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Mumbai's prime office rates continue to rise

The Economic Times, Ramesh Nair

September 26, 2012

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With overall vacancy increasing and business and investor sentiment low, why are office rents in many micro markets in Mumbai still increasing?

In the recent past, many corporate decision makers have been wondering aloud why the rents and capital values in markets such as Lower Parel and Bandra-Kurla Complex have risen in the last four to five months.

The answer is: lack of quality supply in superior locations. It is true that office vacancy levels in Mumbai remain high at 19 percent and that there are many vacant buildings. But it is also true that there is a basic scarcity of available good-quality, right-sized Grade A office stock in the city's prime locations. Corporate tenants who need to relocate, contract, expand or consolidate are still actively scouting for such properties in the CBD (central business district) and SBD (sub-urban business district) areas.

As a result, they are being exposed to high market rates. Lower-priced properties and the incidence of distressed capital values for prime commercial space in Mumbai's preferred corporate office locations are few and far between.

The condition is unlikely to change in the short-to-medium term. The post-Lehman era liquidity fallout on developers has seriously crimped the office development supply pipelines. Also, the new Development Control Regulations (DCR) for Mumbai announced by state government earlier this year does anything but encourage commercial construction. DCR has allotted more fungible FSI to residential construction. The premium payable on fungible FSI for commercial developments is also higher than it is for residential projects.

Moreover, banks, private equity funds and NBFCs (non-banking finance companies) are now more reluctant than ever before to fund speculative construction. All this has further impacted the incidence and potential for new office space launches. Most of the projects currently nearing completion were conceptualized in 2007 or 2008.

Residential property prices in Mumbai are significantly higher than commercial space rates. It is a fact that residential projects are self-funded by buyers, while commercial developers have to wait till building completion to start getting cash inflows thereby reducing cost of funding for developers for residential.

There has been a significant rise in construction costs over the last two years, and commercial capital values in low-priced markets such as Thane and Navi Mumbai are not likely to rationalize despite a 25 percent + vacancy.

All the above mentioned factors will have a definite impact on future commercial supply in the city. This is definitely an opportunity for commercial developers to take a contrarian view and start planning new projects.

Meanwhile, many occupiers from pharmaceuticals, media, logistics, manufacturing and FMCG industries are continuously looking for space in markets such as Lower Parel, Andheri and Western Suburbs. One of the biggest challenges they face is the fact that most of the office developments completed in last few years in here are IT Parks. This means that there are zoning restrictions with regards to types of occupiers which are allowed in them.

The overall commercial space vacancy in the Central SBD micro market (with sub-markets like Lower Parel) is at 24 percent. The vacancy for Grade A, non-IT office space vacancy is only five percent. In the Andheri and Western suburbs micro market, the overall vacancy is around 23 percent but the vacancy for prime Grade A office space is only around 10 percent.

The completion rate for office projects over the next two years will be much lower than in the preceding three years. Many speculative completions will not see the light of day till 2015-2016. Any reasonable improvement in occupier demand will do nothing but add to the pressure on supply, thereby stimulating further increase of rents and capital values in Grade A buildings within the prime locations. A wait-and-watch approach will therefore prove to be a costly stance for occupiers who are intent of opening offices here. Most of the micro-markets have shown indications of having bottomed out.

Interestingly, during the peak of 2007-08, commercial space at Nariman Point's Bhaktawar was transacted at Rs 525/sq ft per month, Peninsula Corporate Park in Lower Parel at Rs 400, Ceejay House in Worli at Rs 700, Silver Landmark in Andheri at Rs 175, Mindspace in Malad at Rs 125, Maker Maxity in BKC at Rs 480 and Oberoi Commerz in Goregoan at Rs 250. This is an indicator that rentals are currently at a reasonable level and that in bull runs, Mumbai can become extremely expensive and unaffordable.

For the predictable future, occupier demand will remain strongly focused on available high-quality commercial spaces. It is in these locations that we are observing increasing rents. In sharp contrast, less preferred markets (in terms of location and quality) are overflowing with available properties at significantly discounted rates.

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