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'Absorption': the most dreaded word in Mumbai realty

High prices, low rentals, no absorption, falling demand and an overheated market. That's Mumbai for you.

Despite indications of sluggish demand for office space, there has been an uptake in absorption in first quarter of 2012. At least that's what property consultants and news reports suggest. In layman speak, absorption is really occupancy, whether rental or bought.

On Wednesday, media reports said that Peninsula Land sold space in its office building in Lower Parel for around Rs 170 crore to financial services firms, marking a bright spot in Mumbai's commercial market.

However, "growing absorption numbers are yet to overtake the existing supply overhang, which has caused the demand-supply gap to widen over the past year," said Samanthak Das, Director - Research & Advisory Services at Knight Frank in the property consultancy firm's latest report.

The research report showed that transaction activity was subdued in the final quarter of the financial year but absorption grew over 23 percent over the fourth quarter last year, proving that the market was gaining momentum. But this is far from being true as nearly 40 million square feet of office space is lying vacant in Mumbai! Vacancy levels have increased from 14 percent in 2009 to 20.6 percent in Q1 2012, said another report by Cushman and Wakefield.

Here are five reasons why the 2012 deals do not paint a rosy picture for the commercial real estate market:

1. Lack of absorption in Mumbai' commercial office space

The Knight Frank report only gives a quarter-on-quarter result , which cannot be used to indicate the outlook for the entire year. Almost all the deals that are taking place this year have been in the pipeline for long while, which means 2012 is just a spill-over-year and not a comeback year, as some surveys have pointed out.

In Mumbai, the lack of absorption is three times the size of Nariman Point. AFP

Anirudh Wahal of DTZ points out that despite an oversupply in the market, 30 million square feet of more office space will be added in the market because of the way these deals are structured. It's not bank money, but public debt and private equity that is used for such projects, he explained. Most investors are long-term investors who only care about capital appreciation and not rental yields. But the problem lies in absorption which indicates whether the market is doing well or not. "All of Nariman Point is equal to 6 million square feet. In Mumbai, the lack of absorption is three times the size of Nariman Point, which is what is putting so much pressure on the rental value." No absorption is also evident from the fact that most of these office buildings were ready way back in 2007, but deals have only begun now.

Key buildings that have major vacancy levels in Lower Parel are Peninsula Business Park A and B where 83 percent and 70 percentspace is yet to be leased. " Even with Peninsula Land selling office space worth Rs 170 crore, the inventory still stands at 50 percent," a Mumbai-based property consultant told Firstpost.

2. Rentals depreciate as absorption rate drops

Office rentals have now fallen to almost one-third (down 36 percent) of what it was three years ago. Yet despite plunging rentals, the area is still witnessing a building boom. Given the oversupply and a fall in demand by 30 percent, developers have now lowered rentals while some are also looking at outright sales of buildings as against leasing them, said DTZ's Wahal.

Rentals in Mumbai's prime commercial realty space in Lower Parel have fallen from Rs 270 a sq foot to Rs 120 a s square foot, while that in Andheri, the price has come down from Rs 100 a square feet in 2009 to Rs 70 now. "Not only have rentals bottomed out but with 44 months of inventory lying unsold, most players have shelved or delayed further construction plans," said Pankaj Kapoor, MD of Liasas Foras, a property consultant firm.

Developersare looking to derisk their assets and get the cash flows coming before a building is actually leased out. Realty major like DLF, Akcruti, Orbit, Alok Realtors the real estate arm of Alok Industries are all looking to dispose off their commercial buildings or are trying to switch commercial projects into residential ones.

3. Reeling developers offering large discounts

Commercial real estate developers, reeling under the pressure of unsold inventory, huge debt and slackening demand from the corporate sector, are now launching affordable offices and attractive schemes. Indiabulls Real Estate is negotiating large deals by offering discounts on the going rate of Rs 150 per sq ft for its buildings at Lower Parel.

Property developer Hubtown recently launched a 40:60 scheme in three of their commercial projects in Mumbai, where they are encouraging the buyer to pay 40 percent now and 60 percent later on.

4. Corporates on a wait-and-watch policy

Renewed concerns of a double dip recession in India in the first half of 2011 has resulted in corporates adopting a 'wait-and-watch' policy, which is why many office spaces are still lying vacant, Rohit Kumar,Head of Research at Property consulting firm DTZ India told Firstpost . "The office demand in 2012-13 is therefore expected to be largely driven by expansion plans held back in 2011 and 2012, and we could continue to see subdued demand in 2012."

Economic contraction has taken place across the spectrum, and with MNCs slashing jobs, relocating, shutting shop in India, demand is going to be low for the next two years. Apart from IT firms which have become conservative in their budgets and are waiting for the global as well as domestic economic environment to improve, even Banking, financial services and insurance, which make up the largest share of Mumbai's office market have put projects on hold.

5. Poor rental yields but disproportionate capital value

Despite rental yields being even lower than fixed deposits, capital value of properties continue to remain high. Why? Because of black money. Foreign investors, PEs are not bothered about yields and continue to pour money into the market, which adds to further speculation in the market. "The black component acts as a buffer to falling rentals, which prevents the capital value from falling. In fact in commercial realty, the black component is as high as 60-70 percent," said Kapoor.