I can't put a finger on a person or entity that got this concept going. Was it Donald Trump or Adrian Zecha who fathered it? Or does the credit go to Four Seasons or some other marquee hotel brand for the same? Or, was it something that evolved as an outcome of the fractional ownership industry where top brands loathe to the road shark selling techniques of timeshare sold a residence with a name guarantee on it. All I do know is that it is an "ego" product that does deliver a quality living space at a hefty price tag and heftier running cost.
Until some 10 years back; exclusive hotel brands marketed residences at equally exclusive resort locations. It did give a nice high to the buyer who felt that (s)he had acquired the whole resort-hotel by just acquiring one unit within it. And, it gave a bigger high knowing that it would not be used and abused by any other person - like a hotel room is - should the owner not wish to put the unit back on a sale and leaseback basis. For a resort developer, this was the perfect way to recover bulk of the cost (if not make a profit) of very expensive and exclusive developments ensuring the project's financial viability.
As real estate markets boomed around the world in the last 10 years; branded residences increasingly became a marketing tool to differentiate exclusive developments from those that were labeled with adjectives like luxury, premium, and unique. The brag rights for owning a branded residence in the city where one lived, as compared to some far flung holiday destinations must have been much greater to warrant this concept being adopted by virtually every major luxury apartment developer around the globe. Soon "Trump Tower" was not only a New York feature and "Four Seasons Residences" could be found alongside virtually every new Four Seasons hotel and at certain locations the requirement of a hotel has been dispensed with altogether. It has in time become the path to viability on super expensive real estate as buyers are willing to pay 60%+ premium over similar unbranded assets. At least that is the story being sold by the brands to the developers; and in a country like India - where the people are very brand and brag conscious - this is God's own truth being said. Well - almost.
The last 2 to 3 years, contrary to market belief; there has seen a dip in luxury apartment sales. The impact of slowdown has hurt this segment of real estate substantially. It is only the innovative off-plan selling by developers - that is - to defer collection of profit and land cost to the end of the project completion (20:80 payment plans) that has facilitated offloading the US$ 1,000,000+ cost apartments. In addition, developers have had to bump up the percentages and fees paid to brokers and consultants to push sales. The selling community never had it so good. Yes, the falling rupee, new wealth, and ease of borrowing for residential inventory has made acquisition of premium goods much easier under the circumstances. But, there is a growing realization that many of these projects may see a longer than planned for project cycle (if at all); and, should the completion happen in a down cycle then those buying for an investment may get burned.
Well, the solution for that is easy - have cash - will talk. If the above was not enough, developers are offering deep discounts to make investor exits less risky and the situation is that branded residences are possibly claiming not more than a 10% - 15% premium over similar class unbranded developments. With brands themselves taking away 10%+ as their fees to lend their names - does it make commercial sense anymore to build one? Buyers that have received delivery of such apartments are now questioning their decision to buy. The recent hike in municipal taxes and utility dues; service tax on maintenance bills; high maintenance costs in corrosive conditions of most Indian cities; inadequate water supply; a lack of quick and proper access to emergency services due to poor infrastructure conditions and emergency equipment; sharing of boundaries with undesirable real estate (slums, cemeteries, local markets); and most important inability to get tenants willing to pay that extra premium in rent has made buying a branded residence a big question for many.
Yes, this land has ego written all over it; but hidden beneath that is a stronger attribute called cost consciousness - the "kitna deti hai" (how much does it average) attitude that overrides the former by miles. I remember the time when I was growing up - the sight of an occasional Mercedes or BMW was a head turner amongst the hundreds of shoddy built local cars. Today; there are hundreds of the big 3 German cars on road blending in unnoticed with thousands of well built cars from Japan, Korea, Europe, and even India. There lies my point that branded residences too will lose their sheen from an ownership brag point of view as more and more hit the RE turf. One would own them purely for self satisfaction and the superior quality and services they promise to deliver albeit at a very high cost. Will they deliver on the promise? Now that's another story and you may want to read my previous blog called "Shitty Shitty Big Brand"
Thursday, November 20, 2014
Wednesday, November 19, 2014
Go InvIT as REIT may be wrong for Indian Hospitality
The hospitality industry in India was probably the first to welcome SEBI's (Securities and Exchange Board of India) decision to permit REITs (Real Estate Investment Trusts). After all REITs have played an important role in furthering the cause of the hospitality sector globally as a major investment asset class. On closer examination however; the set up structure laid out by SEBI does not look too appealing as far as hotels are concerned and in my opinion REITs may be the wrong way to go under the current guidelines. SEBI in its infinite wisdom - and honestly quite rightly - knowing the manipulative mindset that exists in our markets; has put in several checks and balances to protect the investors; but these, while great for real estate - are not really great for the hospitality players.
The key stipulations for a REIT in India:
1. Has to be listed.
2. Minimum corpus INR 5000 million (USD 1 = INR 60)
3. At least 25% offered to the public with a minimum of INR 2500 million
4. 80% of deployment should be in completed assets and minimum of 2 assets required.
5. Single mixed use facility does not qualify for being counted as multiple assets.
6. Maximum of 60% of corpus can be allocated to a single asset.
7. At least 75% of the space owned should be rent earning.
8. No more than 49% leverage permissible on the assets acquired (and is subject to consent of Unit holders)
9. Minimum 51% holding required to qualify as asset ownership.
So effectively, The REIT sponsors would have to create a middle risk company that on one hand would sign a management contract with a hotel operator and also pay a fixed rent to the REIT in order to satisfy the guidelines; as I don't know of many (if any) international hotel operators that would take a property on straight rent for management. There are some Indian operators who make take the risk of a thin fixed and large variable lease linked to operations but then justifying returns to yield based investors may be quite a task.
Then of course there are issues related to tax treatment on the distribution of dividends and interest to Unit holders; as well matters related to Capital Gains tax (applicable) and transfer duties that are making REITs unattractive to even the Real Estate sector.
There is general agreement that an Yield based REIT is not viable but a Yield + growth model may just do it for some subject to getting clarity from SEBI - expected closer to the budget in 2015 when SEBI will probably report a near failure in attracting REIT sponsors to register with it. The poor show has also got to do with the fact that as of now Foreign Investors cannot participate in REITs in India.
Fortunately, SEBI has also laid out guidelines for Infrastructure Investment Trusts (InvITs) that are marginally different than REITs given the nature of the infra sector; but those subtle differences may just make InvITs more inviting to hotels. The key differences being that an InvIT can be set up with a single asset and the rent requirement does not apply in infrastructure. The "Project" will be managed by an independent project manager (bravo - hotel management company). Why do hotels have the privilege of adopting Invits? Well as per Government's notification 3 star and above hotels in Cities/towns with a population of less than 1 million or projects costing more than Rs 200 crores qualify as infrastructure. Why only these? Don't ask me - spin doctoring happens everywhere. Let's be thankful that hospitality now has its 2 legs in 2 different sectors and can take advantage of benefits in both.
For now, the legal and accounting fraternity is raking in the moolah in slicing and dicing the guidelines to create viable structures for their clients. "Trust" is the key word in REITs and InvITs. Transparency, safety and quality along with stable returns is what most institutional and retail investors are after and hopefully both the lawyers and accountants will uphold that fact as primary in advising their clients who would be looking at sponsoring such structures in India.
The key stipulations for a REIT in India:
1. Has to be listed.
2. Minimum corpus INR 5000 million (USD 1 = INR 60)
3. At least 25% offered to the public with a minimum of INR 2500 million
4. 80% of deployment should be in completed assets and minimum of 2 assets required.
5. Single mixed use facility does not qualify for being counted as multiple assets.
6. Maximum of 60% of corpus can be allocated to a single asset.
7. At least 75% of the space owned should be rent earning.
8. No more than 49% leverage permissible on the assets acquired (and is subject to consent of Unit holders)
9. Minimum 51% holding required to qualify as asset ownership.
So effectively, The REIT sponsors would have to create a middle risk company that on one hand would sign a management contract with a hotel operator and also pay a fixed rent to the REIT in order to satisfy the guidelines; as I don't know of many (if any) international hotel operators that would take a property on straight rent for management. There are some Indian operators who make take the risk of a thin fixed and large variable lease linked to operations but then justifying returns to yield based investors may be quite a task.
Then of course there are issues related to tax treatment on the distribution of dividends and interest to Unit holders; as well matters related to Capital Gains tax (applicable) and transfer duties that are making REITs unattractive to even the Real Estate sector.
There is general agreement that an Yield based REIT is not viable but a Yield + growth model may just do it for some subject to getting clarity from SEBI - expected closer to the budget in 2015 when SEBI will probably report a near failure in attracting REIT sponsors to register with it. The poor show has also got to do with the fact that as of now Foreign Investors cannot participate in REITs in India.
Fortunately, SEBI has also laid out guidelines for Infrastructure Investment Trusts (InvITs) that are marginally different than REITs given the nature of the infra sector; but those subtle differences may just make InvITs more inviting to hotels. The key differences being that an InvIT can be set up with a single asset and the rent requirement does not apply in infrastructure. The "Project" will be managed by an independent project manager (bravo - hotel management company). Why do hotels have the privilege of adopting Invits? Well as per Government's notification 3 star and above hotels in Cities/towns with a population of less than 1 million or projects costing more than Rs 200 crores qualify as infrastructure. Why only these? Don't ask me - spin doctoring happens everywhere. Let's be thankful that hospitality now has its 2 legs in 2 different sectors and can take advantage of benefits in both.
For now, the legal and accounting fraternity is raking in the moolah in slicing and dicing the guidelines to create viable structures for their clients. "Trust" is the key word in REITs and InvITs. Transparency, safety and quality along with stable returns is what most institutional and retail investors are after and hopefully both the lawyers and accountants will uphold that fact as primary in advising their clients who would be looking at sponsoring such structures in India.
Tuesday, November 18, 2014
Hotels - It's BUY BUY for some and BYE BYE for many
Flashback circa 2006 - GRI - New Delhi. I was working as a consultant to a Real Estate Fund back then advising it on the hospitality sector, and attended this event on its behalf. All I heard there was that every known and unknown developer attending the conference was going to build more hotels than the number of fingers and toes he had combined in the next 4 to 5 years. Such scale of development had eluded the best of the best in the Indian hospitality industry until then. Each one of them was sold on the story that the whole of India has lesser number of rooms than Bangkok. India had some 90,000 hotel rooms (of which some 50,000 were branded) back then and needed to double its inventory real quick - that is by 2010. Then, I heard a sane voice from one of the attendees (who was leading Accor's initiative in India at that time) that the real number is closer to 500,000 when all forms of temporary accommodation were added up and doubling the inventory was not really the answer. But like all sane voices; it was drowned by the noise created by every hotel and property consultant ridiculing that claim. The great gold rush in the Indian hospitality sector had begun. Projects were being conceived at unheard of land rates with occupancy, average daily rate and valuation assumptions to justify the financial viability to the numerous bankers and private equity players waiting to pour money in this game.
Yesterday; 18th Nov. 2014, I was invited to attend a seminar organized by a leading law firm on "Issues affecting Indian hospitality sector". Got to hear some interesting facts; some amused me and others that got me thinking on what's in store for this sector next. I learnt that the industry compounded annual growth; charted for the last 15 years tells us that demand and supply have kept pace evenly at about 11% with the demand a tad ahead of supply. Then, all hotels should be theoretically clocking at least 80% + occupancy; which is far from the truth. The same statistician rolled out more numbers that the first year performance for new hotel openings has progressively declined from 47% in 2009 to 35% now on account of supply pressures. Occupancy percentages overall for the last 5 years has been stagnant at about 58% and average room rates (ARR) have actually shrunk 3% or more depending on segment. The dark horse holding up the gloom seem to be the 2 star hotel segment that has seen ARRs climb 7.7% in last 5 years with occupancies averaging around 62%. To put all these numbers in a better perspective; India today has some 180,000 hotel rooms across all categories of which 100,000 are branded; and wait; the next couple of years will see the total number cross 250,000 rooms with at least 150,000 of them in the branded category. I am not sure if these totals include the temporary accommodation units as my take is that by year 2016 - India would have close to 1 million units servicing this type of stay need.
As of today, the situation looks more than terrible. Travel around the country and one will see several hotel skeletons doting every city; as much as those of residential and commercial buildings. It's easy to understand why this situation is staring at our face. The nation has gone from a rising to a falling star status in the last 10 years as has its currency. Global economies have not done much better either. Unplanned developments with very little thought, study and planning fanned by developer egos and easy finance from all kinds of investors and lenders has not helped the cause either. From a hotel perspective, the only places that have a smile to show are Mumbai, Delhi (not NCR), Goa and kolkatta. Rest of the Country has over supply written all over it. Pune and Bangalore are inching back to survival from an occupancy but not a rate perspective. Thankfully, India's natural inefficiency in delivering project completion on time has saved the industry from a situation that could have been much worse than it is now. Despite all the technological developments in the construction sector; India still requires an average 29 months to deliver an affordable hotel at a cost of between 24 lakhs to 40 lakhs a room (without land) whereas the same hotel could be built in less than 14 months at the same cost per room inclusive of land. With occupancy and rates continuing to remain the way they are for the next couple of years, most hotels will find it very hard to justify their viability to money backing them. It is certainly going to be a time when a lot of owners holding completed and incomplete assets are going to check-out saying Bye Bye to this industry.
Yet, before the industry decides to cry tears of blood in unison; there is not only a glimmer of hope but a fantastic opportunity waiting out there. Hotel industry usually trails the spurt in economy by about 8 quarters and that means that by 2017-18 the industry should start correcting upward. Anyone committed to this sector and sitting on cash is in a driving position to acquire quality finished and unfinished assets. Specialization in hospitality, along with efficiency in executing projects, managing operations and a strong marketing backbone are keys to winning this game. While I doubt if the Indian REIT structure in its current context will help this sector; hotels being classified as infrastructure can certainly benefit from InvITs (Infrastructure Investment Trusts). Further, the entire lending industry is ready for a reshape and it is not impossible now to get financial institutions to commit longer duration money with repayment programs tailored to the health of the asset - as well as take a more rational approach to security and collateral. I am already hearing the call of Buy Buy getting louder on this street called the "hospitality world".
Pain is good - and like it signals healing in our body - it's also a sign of healing in the industry. Everyone has learnt lessons in the last few years. No longer are hotel brands and operators (new or old) spoiling the developers by offering them ridiculously high fixed leases or making investments in shells that the former do not own or control. Leases and investments are increasingly linked with performance and secured by contracts that make operators virtual owners of the property. Developers have understood that hotels are not the classic real estate business with a build-sell-value formula. Building hotels requires sustainable quality which they don't care for when making inventory to sell; and running hotels needs micro attention which can sap a lot of time from their super profitable construction business - which means finding operators to run their properties. Hiring an operator is not the same as hiring a contractor as developers have learnt and getting away with under performance is now increasing unacceptable as operators have learnt. Recognizing "Prefered Owner Returns"; subordination of fees to debt service; linking fees to operating results are increasingly making life difficult for international brands to conclude business in India and better for domestic operators who understand these issues well - and are ready to commit money if need be to ensure the health of the hotel they put their name on. The best is that most developers are now understanding that the land pricing for and yields from hotels are just not the same as commercial or residential or retail. But, the long term value that wellrun hotels command are unmatched by other spaces they build - and that's driving committed developers into this segment; ones who understand that the pain experienced in the first few years is more than made up by the gain that hotels deliver thereafter.
Yesterday; 18th Nov. 2014, I was invited to attend a seminar organized by a leading law firm on "Issues affecting Indian hospitality sector". Got to hear some interesting facts; some amused me and others that got me thinking on what's in store for this sector next. I learnt that the industry compounded annual growth; charted for the last 15 years tells us that demand and supply have kept pace evenly at about 11% with the demand a tad ahead of supply. Then, all hotels should be theoretically clocking at least 80% + occupancy; which is far from the truth. The same statistician rolled out more numbers that the first year performance for new hotel openings has progressively declined from 47% in 2009 to 35% now on account of supply pressures. Occupancy percentages overall for the last 5 years has been stagnant at about 58% and average room rates (ARR) have actually shrunk 3% or more depending on segment. The dark horse holding up the gloom seem to be the 2 star hotel segment that has seen ARRs climb 7.7% in last 5 years with occupancies averaging around 62%. To put all these numbers in a better perspective; India today has some 180,000 hotel rooms across all categories of which 100,000 are branded; and wait; the next couple of years will see the total number cross 250,000 rooms with at least 150,000 of them in the branded category. I am not sure if these totals include the temporary accommodation units as my take is that by year 2016 - India would have close to 1 million units servicing this type of stay need.
As of today, the situation looks more than terrible. Travel around the country and one will see several hotel skeletons doting every city; as much as those of residential and commercial buildings. It's easy to understand why this situation is staring at our face. The nation has gone from a rising to a falling star status in the last 10 years as has its currency. Global economies have not done much better either. Unplanned developments with very little thought, study and planning fanned by developer egos and easy finance from all kinds of investors and lenders has not helped the cause either. From a hotel perspective, the only places that have a smile to show are Mumbai, Delhi (not NCR), Goa and kolkatta. Rest of the Country has over supply written all over it. Pune and Bangalore are inching back to survival from an occupancy but not a rate perspective. Thankfully, India's natural inefficiency in delivering project completion on time has saved the industry from a situation that could have been much worse than it is now. Despite all the technological developments in the construction sector; India still requires an average 29 months to deliver an affordable hotel at a cost of between 24 lakhs to 40 lakhs a room (without land) whereas the same hotel could be built in less than 14 months at the same cost per room inclusive of land. With occupancy and rates continuing to remain the way they are for the next couple of years, most hotels will find it very hard to justify their viability to money backing them. It is certainly going to be a time when a lot of owners holding completed and incomplete assets are going to check-out saying Bye Bye to this industry.
Yet, before the industry decides to cry tears of blood in unison; there is not only a glimmer of hope but a fantastic opportunity waiting out there. Hotel industry usually trails the spurt in economy by about 8 quarters and that means that by 2017-18 the industry should start correcting upward. Anyone committed to this sector and sitting on cash is in a driving position to acquire quality finished and unfinished assets. Specialization in hospitality, along with efficiency in executing projects, managing operations and a strong marketing backbone are keys to winning this game. While I doubt if the Indian REIT structure in its current context will help this sector; hotels being classified as infrastructure can certainly benefit from InvITs (Infrastructure Investment Trusts). Further, the entire lending industry is ready for a reshape and it is not impossible now to get financial institutions to commit longer duration money with repayment programs tailored to the health of the asset - as well as take a more rational approach to security and collateral. I am already hearing the call of Buy Buy getting louder on this street called the "hospitality world".
Pain is good - and like it signals healing in our body - it's also a sign of healing in the industry. Everyone has learnt lessons in the last few years. No longer are hotel brands and operators (new or old) spoiling the developers by offering them ridiculously high fixed leases or making investments in shells that the former do not own or control. Leases and investments are increasingly linked with performance and secured by contracts that make operators virtual owners of the property. Developers have understood that hotels are not the classic real estate business with a build-sell-value formula. Building hotels requires sustainable quality which they don't care for when making inventory to sell; and running hotels needs micro attention which can sap a lot of time from their super profitable construction business - which means finding operators to run their properties. Hiring an operator is not the same as hiring a contractor as developers have learnt and getting away with under performance is now increasing unacceptable as operators have learnt. Recognizing "Prefered Owner Returns"; subordination of fees to debt service; linking fees to operating results are increasingly making life difficult for international brands to conclude business in India and better for domestic operators who understand these issues well - and are ready to commit money if need be to ensure the health of the hotel they put their name on. The best is that most developers are now understanding that the land pricing for and yields from hotels are just not the same as commercial or residential or retail. But, the long term value that wellrun hotels command are unmatched by other spaces they build - and that's driving committed developers into this segment; ones who understand that the pain experienced in the first few years is more than made up by the gain that hotels deliver thereafter.
Friday, November 14, 2014
Offices or Happy Work Spaces? Disruption in the Real Estate World - Part 2
It's an age of experimentation which allows for disruption. No set rules for how you live, work and play. Ownership is passe - shared is in (almost) - and it even applies to spaces that we thought we had control over. Applying this theorem to workplaces; from cabins and cubicles; to an open work station format; to team benches - the office is evolving. Coffee bar, snooze room, recreation and relax zone, kids pen and many such concepts have moved from being a novelty to a regular feature in large format offices. Innovation is guiding design and prospective employees are making decisions on where they will work and where not despite high unemployment. The new generation is more sure of its capabilities and there is a growing shift away from making lots of money to more in life.
Richard Branson recently announced a work as you please policy allowing his employees to take holidays at will and in return give their best on the days they are working. Such examples are showcasing the extent to which organizations are willing to go to to retain trained employees and get the best out of them. How is that going to impact the way offices are built in India?
Well, if the work environment needs to bring in a fun environment then the decision cannot be driven by bums per square foot seated - which is the case at high cost locations. Mumbai ranks No. 3 in the world for the highest office rents and probably somewhere there for the worst office quality in general. If employers had they ability; they would double deck employees to average out the high costs. But that is changing, If studies are any indication of the truth in the market; then there is a gradual increase in office vacancies happening all over the Country. The national average is about 30% and that's a scary number when one factors in the millions of unfinished square feet waiting to be clad and put on offer. Apart from a few sectors high rents sought in the CBD and SBD locations of this Country are not conducive to running a business. The low cost advantage that India once enjoyed in terms of land and labour is history. We have over inflated our own worth and become globally uncompetitive and that's probably why our real worth has been corrected down 50% in terms of the currencies of measure.
Economics is forcing organizations to down size offices or shift the middle and lower bulk to more economic back room locations. As a result transportation, time and productivity parameters of an employee are being impacted. It's a different matter that many of the office complexes built in remote zones are at wrong locations; the bigger worry is that they have been built wrong too. Then, to top it, to make up for the high cost elements included by the developers to make these swank campuses the rents are off the mark too even though they are less than half of what one would see in CBD and SBD of Metros and T1 cities. In a way, with the aid of technology; its easier to work from home to cut down cost of living and improve quality of life. But in a city like Mumbai where 2 to 3 generations of a family are packed in less than a 1000 ft2 of real and fictitious area - that too is not much of an option.
Gated work-stay campuses are on the rise but that is great for new age sectors. Old world structures cannot easily adapt to such set ups. Ask any developer and he will blame the Government, Goons Global woes and God for the high cost of creating and selling a foot square. His Greed is never a factor. Each time the Government increases the Floor Space Index or FSI (area allowed to be constructed on a ft2 of land) to drive down the overall cost of land; the cost actually goes up because the prevailing land rate is multiplied by the new higher FSI. Redevelopment and regeneration of areas were supposedly planned to usher in lower prices and more open spaces have actually done the reverse as well. Ultimately there will be a situation where the Developer and or his investors will have to go near bald with heavy haircuts to sell or let the spaces not wanting to see a deserted edifice. Private Equity operators believe that REITs are the only hope left to bring in better construction standards and decent rates as the very nature of how a REIT is run depends on these two factors. I disagree as I think that the chain is as strong as its weakest link and REIT's will be run by more or less the same guys who created a mess in the first place.
If it could happen in New York and London - it will happen in Mumbai too. Someday, employees will sing the "Happy" song at happy workplaces because the problem now is an opportunity for a major disruption - and the seed for it must be germinating in some brilliant minds as I write this blog.
Richard Branson recently announced a work as you please policy allowing his employees to take holidays at will and in return give their best on the days they are working. Such examples are showcasing the extent to which organizations are willing to go to to retain trained employees and get the best out of them. How is that going to impact the way offices are built in India?
Well, if the work environment needs to bring in a fun environment then the decision cannot be driven by bums per square foot seated - which is the case at high cost locations. Mumbai ranks No. 3 in the world for the highest office rents and probably somewhere there for the worst office quality in general. If employers had they ability; they would double deck employees to average out the high costs. But that is changing, If studies are any indication of the truth in the market; then there is a gradual increase in office vacancies happening all over the Country. The national average is about 30% and that's a scary number when one factors in the millions of unfinished square feet waiting to be clad and put on offer. Apart from a few sectors high rents sought in the CBD and SBD locations of this Country are not conducive to running a business. The low cost advantage that India once enjoyed in terms of land and labour is history. We have over inflated our own worth and become globally uncompetitive and that's probably why our real worth has been corrected down 50% in terms of the currencies of measure.
Economics is forcing organizations to down size offices or shift the middle and lower bulk to more economic back room locations. As a result transportation, time and productivity parameters of an employee are being impacted. It's a different matter that many of the office complexes built in remote zones are at wrong locations; the bigger worry is that they have been built wrong too. Then, to top it, to make up for the high cost elements included by the developers to make these swank campuses the rents are off the mark too even though they are less than half of what one would see in CBD and SBD of Metros and T1 cities. In a way, with the aid of technology; its easier to work from home to cut down cost of living and improve quality of life. But in a city like Mumbai where 2 to 3 generations of a family are packed in less than a 1000 ft2 of real and fictitious area - that too is not much of an option.
Gated work-stay campuses are on the rise but that is great for new age sectors. Old world structures cannot easily adapt to such set ups. Ask any developer and he will blame the Government, Goons Global woes and God for the high cost of creating and selling a foot square. His Greed is never a factor. Each time the Government increases the Floor Space Index or FSI (area allowed to be constructed on a ft2 of land) to drive down the overall cost of land; the cost actually goes up because the prevailing land rate is multiplied by the new higher FSI. Redevelopment and regeneration of areas were supposedly planned to usher in lower prices and more open spaces have actually done the reverse as well. Ultimately there will be a situation where the Developer and or his investors will have to go near bald with heavy haircuts to sell or let the spaces not wanting to see a deserted edifice. Private Equity operators believe that REITs are the only hope left to bring in better construction standards and decent rates as the very nature of how a REIT is run depends on these two factors. I disagree as I think that the chain is as strong as its weakest link and REIT's will be run by more or less the same guys who created a mess in the first place.
If it could happen in New York and London - it will happen in Mumbai too. Someday, employees will sing the "Happy" song at happy workplaces because the problem now is an opportunity for a major disruption - and the seed for it must be germinating in some brilliant minds as I write this blog.
Disruption in the Real Estate World - Part 1 (Retail)
When the moon is in the Seventh Heaven
And Earth aligns with Mars
Then disruption will guide the planets
And the e-age will steer the stars
No, I have not turned to astrology as a profession; though God knows I would probably make more money professing speculative information that can be never be tested and the listener lapping it up as words from God. Having attended a conference called "What's new: Predictions for the future - Trends shaping Indian Real estate" I am perhaps in a crystal ball gazing mood.
One of the arguments I heard concerned the retail industry. The big question being would e-tailing kill shopping malls. Until a few years back; e-tailing in India was the David and malls the Goliath. Suddenly, the roles seemed to have reversed with e-tailers that were gasping for breath for survival were suddenly valued as billion dollar properties and malls that were demanding billion dollar valuations yesterday are struggling to survive. There are some 500+ malls in India of which only 25% have earned the title of success. Rest are being titled monstrosities ill conceived by egoistic developers and crazy architects who have no idea of where or what they were building or designing, and to what end except for one blinkered thought that India will someday allow FDI in retail and the nation will become the shopping destination of the world.
e-Tailing extracted laughter from these great builders. "People trust only what they can see or touch and will deal only with people they can talk to. After all what fun is shopping if you cannot bargain? Everyone does not have access to the net and those who have don't trust it. This is India my friend not America or Europe" is what I often heard. But, that was before the cheap smartphone wave and suddenly everyone had the net in their palms. Regulation made it compulsory for credit and debit cards to go for higher levels of security and today India has one of the best encryption and secured systems for e-transactions. e-tailers took the feel and touch bit quite seriously and introduced Cash on Delivery, return if not satisfied policies, compare and shop policies. Soon, local retailers suffering from low marketing reach, thin margins and high rents started cutting deals with e-tailers to push their wares.
Air conditioned fancy malls realizing that they had become nothing more than picnic spots for window shoppers started losing tenancies. After all the cost of the high rent is buried in the product you buy. Over the years the smart mall owners learnt to switch from high fixed rents to variable plus thin fixed or no fixed formats to keep good names inside. For many malls, even this was not an alternative. A mall developer today must be thinking that had he invested that same USD 25+ million in developing an e-selling platform rather than the concrete structure he would probably be valued at 10X his investment instead of current land value (that has not changed much) minus 10% (for demolition it) - which is what I heard a large ticket investor say when asked how much he would pay to acquire a distressed mall.
In this David and Goliath war; the new David seems to be making the same mistake - but on the other extreme. Selling goods below cost with an eye on customer acquisition. Sustainable? I don't know. I still feel e-tailing cannot offer the smell of printed books of a bookstore or the smell of bakes and coffee at a coffee shop or any of the sensory and social experiences of a mall. Malls are and will be the place for E(xperience)-tailing. The way they are built may change over time as well as the way business is transacted. Maybe each of the e-tailers will end up owning its own mall in every City or town or maybe they will be defined by a product range they sell. But they will survive and even flourish. India cannot keep FDI in retail out for long and global pressures will force it to happen.
It is very clear however that Real Estate is no longer immune to disruption. Its happened in retail and its happening in office spaces too (Part 2). It's time for developers to open their eyes and realize that they have to change the way they build and do business.
And Earth aligns with Mars
Then disruption will guide the planets
And the e-age will steer the stars
No, I have not turned to astrology as a profession; though God knows I would probably make more money professing speculative information that can be never be tested and the listener lapping it up as words from God. Having attended a conference called "What's new: Predictions for the future - Trends shaping Indian Real estate" I am perhaps in a crystal ball gazing mood.
One of the arguments I heard concerned the retail industry. The big question being would e-tailing kill shopping malls. Until a few years back; e-tailing in India was the David and malls the Goliath. Suddenly, the roles seemed to have reversed with e-tailers that were gasping for breath for survival were suddenly valued as billion dollar properties and malls that were demanding billion dollar valuations yesterday are struggling to survive. There are some 500+ malls in India of which only 25% have earned the title of success. Rest are being titled monstrosities ill conceived by egoistic developers and crazy architects who have no idea of where or what they were building or designing, and to what end except for one blinkered thought that India will someday allow FDI in retail and the nation will become the shopping destination of the world.
e-Tailing extracted laughter from these great builders. "People trust only what they can see or touch and will deal only with people they can talk to. After all what fun is shopping if you cannot bargain? Everyone does not have access to the net and those who have don't trust it. This is India my friend not America or Europe" is what I often heard. But, that was before the cheap smartphone wave and suddenly everyone had the net in their palms. Regulation made it compulsory for credit and debit cards to go for higher levels of security and today India has one of the best encryption and secured systems for e-transactions. e-tailers took the feel and touch bit quite seriously and introduced Cash on Delivery, return if not satisfied policies, compare and shop policies. Soon, local retailers suffering from low marketing reach, thin margins and high rents started cutting deals with e-tailers to push their wares.
Air conditioned fancy malls realizing that they had become nothing more than picnic spots for window shoppers started losing tenancies. After all the cost of the high rent is buried in the product you buy. Over the years the smart mall owners learnt to switch from high fixed rents to variable plus thin fixed or no fixed formats to keep good names inside. For many malls, even this was not an alternative. A mall developer today must be thinking that had he invested that same USD 25+ million in developing an e-selling platform rather than the concrete structure he would probably be valued at 10X his investment instead of current land value (that has not changed much) minus 10% (for demolition it) - which is what I heard a large ticket investor say when asked how much he would pay to acquire a distressed mall.
In this David and Goliath war; the new David seems to be making the same mistake - but on the other extreme. Selling goods below cost with an eye on customer acquisition. Sustainable? I don't know. I still feel e-tailing cannot offer the smell of printed books of a bookstore or the smell of bakes and coffee at a coffee shop or any of the sensory and social experiences of a mall. Malls are and will be the place for E(xperience)-tailing. The way they are built may change over time as well as the way business is transacted. Maybe each of the e-tailers will end up owning its own mall in every City or town or maybe they will be defined by a product range they sell. But they will survive and even flourish. India cannot keep FDI in retail out for long and global pressures will force it to happen.
It is very clear however that Real Estate is no longer immune to disruption. Its happened in retail and its happening in office spaces too (Part 2). It's time for developers to open their eyes and realize that they have to change the way they build and do business.
REITs and RIET of Real Estate
There seems to be a heady buzz in the Real Estate (RE) sector on the back of the new FDI (Foreign Direct Investment) policy and the new reality of Real Estate Investment Trusts (REITs) announced by the current government. This excitement was clearly evident at a conference that I attended on real estate organized by the Royal Institute of Chartered Surveyors (RICS). I am always keen to hear where this sector is headed as hotels are an integral and important part of this core sector. The theme stated "What's New: Predictions for the future - Trends shaping Indian Real Estate". It covered residential, retail, commercial segments; and nothing about hotels. Nothing; not even a mention in any one of the topics discussed. So, from being the super star - flavour of the season - and what not a few years back; this segment seems to have seriously fallen to the bottom of the barrel for the RE guys. I took consolation in the thought that maybe hospitality now truly belongs to the Infrastructure sector and not "Real Estate" and will probably get better visibility at larger - more important - forums. In all honesty, even I know that hospitality is no longer hot property with RE given the number of deals falling on my table for rescue. But, this is not a blog on hotels. (Guys! eggs and tomatoes are expensive so think before you toss them at anyone - especially someone who can do miracles with them).
Back to the topic. The new FDI policy has considerably reduced the project qualification requirements to allow much smaller projects to be consider for funding. Idea being to encourage growth in T2 and T3 towns with a larger agenda to promote SMART cities in those locations. There seems to be a lot of scepticism if it will actually achieve it's goal as FDI of now will rarely chase high risk. The beneficiaries may be smaller projects in Metro and T1 Cities and small to medium size developers with a good track record in delivery and with a professional team that treats that money with respect will end up as the real winners. But, there is a social change emerging in the way the younger generation perceives life. No longer is there a thirst to go Urban with the high cost and high stress lifestyle associated with it; rather go RURBAN where the lifestyle is relaxed; costs of living are low and where one does not live in a pigeon hole. That is the real SMART city of tomorrow and I have come across examples of villages that have transformed themselves into clean, green, eco-sensitive, reliant on renewable energy, with 100% literacy, completely net connected and so on.
http://www.scoopwhoop.com/inothernews/mera-gaon-mahaan/?ref=social&type=fb&b=0
I actually hope that FDI becomes the RIET choice (Rural India's Economic Thrust). However, attracting FDI today may be a bit of challenge. Yes, there is a strong case for India to attract capital for real estate - afterall there are very few places left in the whole wide world that actually can. But, the real returns on capital that had come into India between 2006-7 to 2009-10 (good times) is barely in single digits when one considers that the Rupee has depreciated 50% in the last 4 years and that it is hard to quote successful exits to begin with. Moreover, the end of "Quantitative Easing" in the USA - the interest rates overseas may slowly and steadily inch up making investments in emerging markets a tad more unattractive. Then, do we need foreign money when there is so much money in India itself? That is exactly the belief many fund managers have - having raised tons of money locally for the RE sector. Investors, both big and small believe that deploying money in RE through an institution is a lot better given its better abilities to conduct the due diligence much as well as secure the property as tightly a bank would. So, Indian money raised has been more structured debt at high interest rather than pure risk high return private equity. Most FDI post 2009 has also come in the same form to ensure a year on year return at a rate when adjusted would match the high interest rates charged by banks.
The developers were the happiest when they got PE money as there was no pressure to guarantee any form of return. Guess they were not the only greedy ones and those in control of giving out development permissions joined the party and no one really cared as playing on "Other People's Money" was always fun. No transparency, no reporting requirements, no project takeover threats either, and with local litigation laws being the way they are; the developer was under no threat at all. I know of cases where developers have asked Board Members representing their PE investors to exit at super low returns or not see a single rupee be returned for the next 100 years. Well wisdom does catch up and that's the reason why nearly 60% of the money brought in by PE from overseas sits undeployed.
The money sitting on the fence is waiting for the final brushes on the REITs policy to facilitate purchase a portfolio of good quality, income earning assets at good locations and get the required returns on capital through listing exits. While there is excitement that it will improve quality of construction, bring in transparency and become a source for raising funds for those with a proven track record; REITs will compete more with debt instruments in terms of returns; and with equities returning into the favourable zone with investors - will find it hard to attract capital to itself.
As a sector, real estate in India is suffering from "premature obesity" created by over inflated valuations by the greedy few that control the market. The actual user is still not the buyer and inventory meant to make housing and commerce more affordable is actually being bought by the very people who should not. Luckily for all, India is looking to enter its growth cycle and the excess inventory in all segments may soon find actual buyers. A massive correction will help; but that's not happening anytime soon as most developments have come up on no-pressure money. That in itself will keep new money away from the sector as at current values most acquisitions are unable to give healthy returns. Property Consultants and Developers believe that Indian RE sector is still an infant given the rising population and wealth in India. They have no choice but to believe that. Yet across the border a more populous and richer nation has swanky vacant dead cities that no one wants to go to.
I will not put a wreath on Real Estate anytime soon; but it's time the arrogance of this industry took a hard beating before it becomes to look like a snake eating its own tail - where one does not know if it is reinventing or killing itself.
Back to the topic. The new FDI policy has considerably reduced the project qualification requirements to allow much smaller projects to be consider for funding. Idea being to encourage growth in T2 and T3 towns with a larger agenda to promote SMART cities in those locations. There seems to be a lot of scepticism if it will actually achieve it's goal as FDI of now will rarely chase high risk. The beneficiaries may be smaller projects in Metro and T1 Cities and small to medium size developers with a good track record in delivery and with a professional team that treats that money with respect will end up as the real winners. But, there is a social change emerging in the way the younger generation perceives life. No longer is there a thirst to go Urban with the high cost and high stress lifestyle associated with it; rather go RURBAN where the lifestyle is relaxed; costs of living are low and where one does not live in a pigeon hole. That is the real SMART city of tomorrow and I have come across examples of villages that have transformed themselves into clean, green, eco-sensitive, reliant on renewable energy, with 100% literacy, completely net connected and so on.
http://www.scoopwhoop.com/inothernews/mera-gaon-mahaan/?ref=social&type=fb&b=0
I actually hope that FDI becomes the RIET choice (Rural India's Economic Thrust). However, attracting FDI today may be a bit of challenge. Yes, there is a strong case for India to attract capital for real estate - afterall there are very few places left in the whole wide world that actually can. But, the real returns on capital that had come into India between 2006-7 to 2009-10 (good times) is barely in single digits when one considers that the Rupee has depreciated 50% in the last 4 years and that it is hard to quote successful exits to begin with. Moreover, the end of "Quantitative Easing" in the USA - the interest rates overseas may slowly and steadily inch up making investments in emerging markets a tad more unattractive. Then, do we need foreign money when there is so much money in India itself? That is exactly the belief many fund managers have - having raised tons of money locally for the RE sector. Investors, both big and small believe that deploying money in RE through an institution is a lot better given its better abilities to conduct the due diligence much as well as secure the property as tightly a bank would. So, Indian money raised has been more structured debt at high interest rather than pure risk high return private equity. Most FDI post 2009 has also come in the same form to ensure a year on year return at a rate when adjusted would match the high interest rates charged by banks.
The developers were the happiest when they got PE money as there was no pressure to guarantee any form of return. Guess they were not the only greedy ones and those in control of giving out development permissions joined the party and no one really cared as playing on "Other People's Money" was always fun. No transparency, no reporting requirements, no project takeover threats either, and with local litigation laws being the way they are; the developer was under no threat at all. I know of cases where developers have asked Board Members representing their PE investors to exit at super low returns or not see a single rupee be returned for the next 100 years. Well wisdom does catch up and that's the reason why nearly 60% of the money brought in by PE from overseas sits undeployed.
The money sitting on the fence is waiting for the final brushes on the REITs policy to facilitate purchase a portfolio of good quality, income earning assets at good locations and get the required returns on capital through listing exits. While there is excitement that it will improve quality of construction, bring in transparency and become a source for raising funds for those with a proven track record; REITs will compete more with debt instruments in terms of returns; and with equities returning into the favourable zone with investors - will find it hard to attract capital to itself.
As a sector, real estate in India is suffering from "premature obesity" created by over inflated valuations by the greedy few that control the market. The actual user is still not the buyer and inventory meant to make housing and commerce more affordable is actually being bought by the very people who should not. Luckily for all, India is looking to enter its growth cycle and the excess inventory in all segments may soon find actual buyers. A massive correction will help; but that's not happening anytime soon as most developments have come up on no-pressure money. That in itself will keep new money away from the sector as at current values most acquisitions are unable to give healthy returns. Property Consultants and Developers believe that Indian RE sector is still an infant given the rising population and wealth in India. They have no choice but to believe that. Yet across the border a more populous and richer nation has swanky vacant dead cities that no one wants to go to.
I will not put a wreath on Real Estate anytime soon; but it's time the arrogance of this industry took a hard beating before it becomes to look like a snake eating its own tail - where one does not know if it is reinventing or killing itself.
Tuesday, November 11, 2014
Make in India
I don't know if anyone can remember; but there was a time when Japan was laughed upon for its manufacturing abilities. It's hard to even find articles on the net referring to that period when Japan was notorious for cheap, badly made knock offs of almost everything under the sun from cars to cameras. Over time Japanese pride changed the image and soon "Made in Japan" stood out as a brand in itself. It overtook the world in technology and in the World War of economics; almost took over the entire world. Many smaller nation like Korea, Malaysia, Thailand and Taiwan tried to imitate the Japanese model but with limited success. China is probably the only nation that has succeeded in a variation of what the Japanese did by cloning and owning (as its own) ideas rather than coming up with path breaking new ideas. In time that too may change as is the fact that "Made in China" though not a brand in itself - is now a given for the entire manufacturing spectrum from bad to the best for everything made in the world.
India on the other hand; despite having a relatively freer economy as compared to the Chinese some 30 years back - lost out in the race to become a world manufacturing hub despite its so called low cost labour advantage. I have tried to search for answers and have come up with a conclusion (right or wrong) that India's failure stems from a lack of belief in the concept called "national pride". We are Maharashtrians or Punjabis or Tamil or Gujarati first - Indian second. Somehow; years of foreign rule has brainwashed us that "imported" is better and that has kind of become a self fulfilling prophecy. It's a different matter that the manufacturing policy is based on a system of entry-exit and operational hurdles that is the biggest put off for manufacturing anything in this Country; but those who do know how to bend the system and thrive in an environment that encourages evasion, cheating, sub standard and inconsistent quality among a list of several negatives. In general; being mediocre is fine - produce now and refine later is the manufacturing mantra - knowing well that the demand is limitless for the scarce goods produced as a result of which the consumer will lap up anything without recourse the very limited consumer protection systems in place.
The malaise is so contagious that even foreign brands that have set up shop in India are now getting used to accepting quality defects in their famed zero tolerance production lines as a part of life here. Consumers too for some reason have no will to complain about shoddy service or products being dished to them. Too busy to make the effort or too low down in the pecking order to be taken notice of.
Will a change of laws alone bring about a change in the Indian manufacturing context? Laws have no effect on the level of corruption in this nation and I am not referring to monetary corruption alone. Increase in productivity, management and labour attitude, adherence to quality standards, ethics, and a host of other measurable intangibles have to kick in to make "Make in India" a success. India does not lack in innovation or entrepreneurship - there are plenty of examples to substantiate it - right from our "Mission to Mars" to the several "Rags to Riches" heros. All we need to "Make ourselves in India" first and before you know it several Indian brands will be a household feature across the globe.
India on the other hand; despite having a relatively freer economy as compared to the Chinese some 30 years back - lost out in the race to become a world manufacturing hub despite its so called low cost labour advantage. I have tried to search for answers and have come up with a conclusion (right or wrong) that India's failure stems from a lack of belief in the concept called "national pride". We are Maharashtrians or Punjabis or Tamil or Gujarati first - Indian second. Somehow; years of foreign rule has brainwashed us that "imported" is better and that has kind of become a self fulfilling prophecy. It's a different matter that the manufacturing policy is based on a system of entry-exit and operational hurdles that is the biggest put off for manufacturing anything in this Country; but those who do know how to bend the system and thrive in an environment that encourages evasion, cheating, sub standard and inconsistent quality among a list of several negatives. In general; being mediocre is fine - produce now and refine later is the manufacturing mantra - knowing well that the demand is limitless for the scarce goods produced as a result of which the consumer will lap up anything without recourse the very limited consumer protection systems in place.
The malaise is so contagious that even foreign brands that have set up shop in India are now getting used to accepting quality defects in their famed zero tolerance production lines as a part of life here. Consumers too for some reason have no will to complain about shoddy service or products being dished to them. Too busy to make the effort or too low down in the pecking order to be taken notice of.
Will a change of laws alone bring about a change in the Indian manufacturing context? Laws have no effect on the level of corruption in this nation and I am not referring to monetary corruption alone. Increase in productivity, management and labour attitude, adherence to quality standards, ethics, and a host of other measurable intangibles have to kick in to make "Make in India" a success. India does not lack in innovation or entrepreneurship - there are plenty of examples to substantiate it - right from our "Mission to Mars" to the several "Rags to Riches" heros. All we need to "Make ourselves in India" first and before you know it several Indian brands will be a household feature across the globe.
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