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Residential developers turn to commercial realty, in search of greener pastures
Housing.com  |  June 17, 2019

Ravi Sinha

With commercial real estate offering decent returns, several residential developers are foraying into this segment. We look at the reasons behind such moves and whether such ventures are likely to succeed

 

The real estate market has, on numerous occasions, witnessed the launch of projects in the SEZ, retail, luxury housing or even affordable housing segments, without any market rationale. This has often led to oversupply in that given segment, or the particular micro-markets, where such projects have been launched. It is in this background, now, that some of the residential property developers are foraying into commercial projects.

 

There is a general perception that developers are launching such projects, as they are on the lookout for greener pastures. While developers may be lured by the profit margins in such segments, their execution capabilities and business model remain doubtful.

 

The absorption of office space has been upwards of 40 million sq ft per annum, for the last three years. The overall sentiments in this segment look bullish, with private equity (PE) investors also putting in money. Even in retail real estate, PE investors have been bullish and are exploring tier-2 cities having malls with good footfalls, brand mix and strong sales. While the residential real estate segment operates on an outright sales model, commercial spaces are by and large operating on the lease model.

 

The trend of residential developers shifting to commercial spaces, hence, raise several questions:

 

  • Is it because the residential sector is not performing a well as the commercial segment?
  • Is it a desperate move for better cash flows?
  • Do these residential developers have expertise in leasing?
  • Does commercial spaces have as big a market, in terms of cities, as residential?
  • Are these residential developers getting into the commercial segment, because of an anticipated rush for REIT listings, in the future?

 

Reasons for developers foraying into commercial realty

 

Evidence, however, indicates that Indian property developers have by and large failed with non-core expertise areas. There are only a handful of developers in India, who have been successful in all the segments of real estate. Several property analysts believe that the quest to be seen as a full-scale developer, with a diversified portfolio, is what is driving the developers towards the commercial segment.

 

“With sources of capital in the market being squeezed fund-raising becoming a concern, the developers are diversifying their portfolios and getting into commercial real estate. Most of the credit rating agencies and analysts are more bullish on commercial real estate. Having said that, I have my doubts as to how many of these developers would actually succeed in a segment that demands very different kind of skill sets,” opines Rakesh Kadam, a property consultant in Ahmedabad.

 

On being asked whether it is lucrative for residential developers to switch to commercial real estate, Nikhil Hawelia, managing director of the Hawelia Group says that the issue is not about what is lucrative but what is feasible. According to him, unless one has the expertise in leasing and corporate tie-ups, one would not succeed in commercial real estate.

 

“It is like asking whether I should now get into any other sunrise industry, for greener pastures. My expertise is in making houses and for me retail or office space would be a new ball game altogether. Even if I am open to a new learning curve, I must be conscious of the fact that it will not be a smooth transition. Nevertheless, the market is definitely rosier in commercial real estate today,” Hawelia explains.

 

Business model for success in commercial real estate

 

The opinion of the developers by and large, is quite guarded at this point of time. Dhaval Shah, joint managing director of the Parinee Group, feels that understanding the demand in the market is essential, before any initiative in this segment.

 

According to him, lots of developers are making large space offices and targeting corporate clients on a lease model and very few developers are focusing on small boutique office spaces which is on the sale model, or targeting SMEs and start-ups which is an alternative to a space-sharing model. “The major commercial projects are launched mostly by the top 20 developers who are in the industry for more than a decade. So, they do take things in to consideration before launching it. New developers are not much in the commercial space scenario,” says Shah.

 

Aditya Kedia, managing director of Transcon Developers, maintains that the basic skill set for constructing commercial premises is not very different from residential premises. However, the marketing skills shall play a very important role. Apart from this, the location of the commercial premises and whether it is a co-working or shared space, or office-retail complexes, will be important considerations. “The long-term picture for Indian commercial realty still looks optimistic. While some segments like housing and land continue to remain under slight pressure, commercial leasing activity has been vigorous, with Grade-A spaces witnessing stable increase in rentals, assessments and valuations. The business environment has also witnessed the emergence of some novel trends that are all set to make the real estate developers’ commercial journey nothing short of an enriching one, full of opportunities that can be used to their advantage,” Kedia insists.

 

While it may be too early to conclude whether residential developers would succeed or fail in commercial real estate, the transition is unlikely to be a smooth one for developers looking for greener pastures.

 

(The writer is CEO, Track2Realty)