Commercial real estate will continue to face significant pressure in near term: ICRA

NEW DELHI: The commercial real estate sector will continue to face significant pressure in the near term owing to the continuing impact of the Covid-19 pandemic on both the office and retail leasing segments, according to ICRA Ratings.

With the second wave peaking in Q1 of FY22, the sector is expected to confront similar challenges as in FY21. While the retail leasing segment prospects are intricately linked to the recovery in retail sales and discretionary consumption spending by the urban population, demand recovery in office leasing segment is influenced by multiple factors as corporate occupiers evaluate the challenges and opportunities created by the pandemic on their real estate resource planning.

Shubham Jain, group head & senior vice president, Corporate Ratings, ICRA, said, “Though cash flows remained materially unimpacted in FY21, we are seeing increasing vacancy levels in the rated portfolio as the pandemic has resulted in deferment of new leasing transactions by tenants while the available inventory builds up in line with scheduled completions.”

The delay in conclusion of new leasing is on account of multiple factors including restrictions on international travel and deferment of decision making until there is clarity on employees returning to offices at earlier numbers.

“To some extent, corporates could also be evaluating the potential for them to reduce their real estate footprint through implementation of hybrid work models including work-from-home, flexi-seating, etc. While the factors that have supported the high level of absorption of office space in the country in the past – viz, abundant and cost competitive talent pool – remain intact, the evolving work practices in response to the pandemic may create, at best, a temporary deferment of leasing decisions or, in the worst case, a permanent reduction in the demand for real estate space,” he said.

The cash flow pressures on the retail leasing segment are more evident in the near term as state level lockdowns and restrictions on mall operations impact the tenants’ revenues and will translate into rent concessions being granted by mall operators.

As retail operations eventually recover from the impact of the pandemic, the rental collections are also expected to revert to the earlier levels. Nonetheless, the timelines for such recovery will depend on the pace of vaccinations in the target consumer segment for retail malls, as well as the revival in consumer sentiments following the adverse impact that the second wave had on disposable incomes.

The rising share of retail sales cornered by e-commerce marketplaces will also have an impact on the trading values of traditional retailers in malls, thus impacting the business profile of the mall operators as well.

“The first wave had resulted in reduction in net operating income of retail malls by up to 50% in FY21. However, the recovery in operating metrics witnessed in the second half of last fiscal would have been heartening for the industry. The prospects for such a steep recovery in FY22 could be dampened by the income shock created by the second wave due to the associated healthcare costs that many families incurred. Over the medium term, the industry is likely to see a shift towards more experience based outlets rather than pure retail stores as malls combat the rising share of e-commerce in overall retail,” Jain added.

The credit outlook for the retail leasing segment remains negative due to the high level of cash flow disruption in Q1 and the rest of the year, particularly in the absence of regulatory measures such as moratorium on debt servicing, which had supported liquidity in FY21.