Real Estate in India: A Survival Guide

India has experienced near-double-digit growth in the last several years and stories of the Indian economic juggernaut fill newspapers and bookstores. The commercial real estate market is no exception. The IT boom has created a huge demand for quality office space that was nonexistent a few short years ago. Several prominent Indian developers have emerged, and more and more international investors and developers are plunging into the country.

As with any local or regional market, there are many idiosyncrasies that color the business environment, and India is no exception. Below is an introduction into the current conditions within the Indian real estate market and what the future may hold as India quickly becomes a global superpower.

What City am I looking at?

India is a large country with an even larger population, and multi-national companies are taking a strategic approach to capitalize on this growing market and rich pool of talent. In terms of establishing office locations, most companies consider three types of cities:

Tier I cities are the hubs of business. The financial capital of Mumbai, the political capital of Delhi, and the technology capital of Bangalore are the first destination for most corporations and real estate demand and rental pricing reflect this. Consider this: office space in a prime location such as Nariman Point in Mumbai costs upwards of 350 Rupees per square foot per month (or approximately $105 per square foot per year), making it one of the most expensive real estate markets in the world. While bursting demand and constrictions on new supply have propelled rental rates, these cities face significant infrastructure issues, particularly road congestion, and the capital markets environment is somewhat stymied due to the prominence of strata title and opaque ownership history, specifically on older, more established assets in downtown locations.

Tier II cities such as Chennai, Hyderabad and Pune are the burgeoning centers of IT commerce. With large populations, developing infrastructure, airport connectivity and top-notch educational institutions, many companies look to establish large operational hubs here. While demand for space in these cities remains strong, stronger interest by developers has caused inflated land prices and many markets are predicting an oversupply of new office supply in the next ten to eighteen months. As a result, rental rates are leveling in many cities after several years of growth.

Too many to list, Tier III cities are those that have yet to see the formation of a formal real estate market, but to varying degrees have the right ingredients to attract multi-national tenants. Corporate occupiers are increasingly looking to gain first-movers advantage into cities such as Kolkata, Chandigarh, Kochi, Coimbatore and Vishakapatnam due to the potential of untapped labor markets and heavily discounted real estate costs that accompany less established locations. In light of rising costs, particularly in real estate and human capital, and a weaker dollar, these cities in coming years are sure to provide plenty of competition to Tier II cities.

What to Expect

Despite early signs of the market reaching a peak, most of India’s cities continue to be overwhelmingly a landlord’s market. All cities are still seeing multiple leases and active requirements from 100,000 to over 1 million square feet, and tenants are sometimes forced to wait months for the completion of core shell construction to start the hiring process for their new operations. Tenants are faced with the resulting conditions: no tenant improvement allowance, free rent periods that are only given during fit-out construction, and maintenance charges up to twenty percent above cost.

Things to Look Out For

A relatively young democracy – celebrating its 60th year of independence this year – India is still maturing economically and politically, and a thorough due diligence is required when considering India from an occupier or investor perspective. Local developers are still responsible for the majority of new supply in most markets and their reliability on timelines and construction quality varies. State governments play a key role in the viability of any particular market and a shift in power can cause major changes in the growth patterns of a city. Furthermore, the economic vehicles created for IT companies are a source of much debate. STPI, or Software Technology Parks of India, is a longstanding government agency, which provides tax benefits until 2009, and the extension of these benefits is unclear. The result of this is that the majority of new requirements are looking at Special Economic Zones, or SEZs, which allow for up to 15 years of tax holidays for both occupiers and developers. However, frequent changes in SEZ policy require companies to create a customized strategic plan with their tax consultant before commitment and occupancy. Likewise, there is no clearly defined exit strategy for SEZs and developers are currently required to adopt a long-term hold strategy on these assets.

The Future

Despite volatility in the US and elsewhere due to sub prime lending, Indian equity markets have remained strong, and this means companies from the subcontinent are quickly reaching market capitalizations and credit levels that allow for major acquisitions abroad. According to Grant Thornton, in the first eight months of 2007, there have been 164 acquisitions by Indian companies worth nearly $31 billion, compared to 73 in-bound deals worth $15 billion. Global brands such as Tetley Tea are already Indian-owned and Tata Steel made headlines early this year with its $12 billion acquisition of Corus Steel to become one of the world’s largest steelmakers. Indian realty major DLF made its Initial Public Offering in June and reached a market capitalization of over $20 billion, rivaling the sale price of Equity Office to Blackstone last year. Interest in institutional assets abroad is only inevitable and don’t be surprised to see Indian real estate majors such as DLF and Unitech or conglomerates such as Reliance and Tatas owning premium real estate assets in major US markets in the coming years.

India offers an unparalleled opportunity to participate in one of the fastest-growing economies in recent history. India’s integration into the global marketplace can be measured on a daily basis, and the most successful real estate occupiers and investors will be willing to adopt a flexible strategy that works with the country through this growth phase. If you do business here, look beyond the confronting challenges of overcrowded streets, poor infrastructure and still-pervasive poverty, and you’ll find a country of wonderful people, beautiful scenery, colorful history and plenty of opportunity. The Indian tiger is ready to pounce.