04 Jun 2020 20:23 IST

Office space segment faces near-term headwinds on Covid impact

More people working from home and impact of the global slowdown on MNCs in India will hurt the sector

Commercial real estate, particularly the office space segment, had been resilient at a time when the residential segment was witnessing a demand slowdown. The leasing activity of office spaces grew around 9 per cent (CAGR) in the last five years from 2015 to 2019. Given the lack of quality office space, prominent developers, including Embassy, DLF and Phoenix Mills, continued to expand their commercial properties. According to a report by Anarock, a real estate consultant, leasing activity for the year 2019 (CY) grew 19 per cent y-o-y.

However, since the outbreak of the Covid-19 pandemic, the buoyant office space market is witnessing a slowdown. With many corporates encouraging their employees to continue working from home, working spaces could face a significant slowdown in demand. Also, new leasing activities may not pick up in the upcoming quarters, given the economic uncertainties. While the rentals for developers could also come under pressure, players with a strong balance sheet may withstand the storm better.

Short-term challenges

Since the imposition of the lockdown to contain the spread of the virus, many business activities have come to a standstill. The stocks of major commercial property developers, including Embassy Office Park REIT, Oberoi Realty, DLF and Phoenix Mills, were down nearly 26 per cent on an average (ytd).

While the restrictions on movement are slowly being lifted in many cities, office space demand is expected to contract 17 to 34 per cent, according to the Anarock report. This is due to several headwinds in the market.

One, key companies in IT/ITeS, including TCS and Tech Mahindra, which take up most of office space demand, have plans to make work-from-home a permanent option for their employees, at least for a year. Two, 40-50 per cent of Indian office space is taken up by multinational companies, mostly based out of the US and Europe. If the slowdown in those economies continues, the impact on Indian office space demand could be more pronounced in the coming quarters.

Deferred decisions

This is evident in the case of Embassy Office Parks REIT, one of the largest players in the commercial property segment. According to its management, leasing decisions will likely be deferred over the next few months while the corporate occupiers figure out long-term strategy (with respect to work from home).

Also, with uncertainties in demand recovery, businesses are deferring their future leasing decisions. According to a Cushman and Wakefield report, for the first quarter (CY2020), rental pre-commitment was only 2.36 msf (million square feet) compared to 10.37 msf in the previous quarter. The rental pre-commitments from clients of Embassy REIT are likely to be impacted for the next 1-2 quarters.