With the interest for Indian commercial properties on the ascendant amongst the private equity, global sovereign and pension funds, the valuation of office and retail assets is witnessing a corresponding increase. Capitalsation rate, the ratio of net operating income (NOI) to property asset value, has seen significant compression indicating the surge in valuation of these assets.
Capitalisation rate has gone down to 7.5%-9% from its earlier high of 11% and the unprecedented investors’ interest is expected to compress it further by up to 150 basis points in the coming years. Investors of such properties are expecting to reap dual benefits, firstly from the growth in rental income and, secondly, from compression in capitalisation rates as capital values would also appreciate further.
“Cap rates compression means value of assets going up. Investors who are entering the commercial property market now will have to pay more. However, by the time they exit after 5-7 years, 150-200 basis points compression would give them sufficient upside through capital value and rental appreciation,” said Samantak Das, chief economist and National Director-Research, Knight Frank India.
Indian real estate has attracted private equity investments worth $15.9 billion, including equity and debt, over the past two years in 2016-17 and 2017-18. Out of this, $7.3 billion, or nearly 50%, was invested in commercial real estate including offices and retail properties, showed data from Knight Frank India.
“Capitalisation rate going down has more to do with liquidity that is chasing quality income-producing assets. Indian market is at a nascent stage and the liquidity premium related to REITs is not there right now. As we start witnessing REIT listings, this liquidity premium will pull capitalisation rates further and that works in favour of investors who have built their positions earlier,” said Ambar Maheshwari, CEOPrivate Equity, Indiabulls Asset Management Company.
With the spate of reforms introduced by the government, the business environment has become more transparent, and the Indian real estate sector is witnessing a robust rise in investment inflow as both foreign and domestic institutional investors are pumping in more funds into the sector.
Large global institutional investors, including Blackstone Group, Brookfield Asset Management, GIC, Canada Pension Plan Investment Board (CPPIB), Goldman Sachs and Qatar Investment Authority, have been investing aggressively in Indian real estate assets over the past few years.
In addition to this, more funds are on the lookout for investment and alliance opportunities in the backdrop of recent policy reforms. While these entities had earlier shown interest in investing in commercial real estate, they are ramping up their investment portfolios in the backdrop of opening up of an avenue for monetization through Real Estate Investment Trusts (REITs).
However, experts also said that with respect to expectations of capitalisation rate compression, one needs to be cautious. Globally, the days of zero or low interest rates regimes are coming to an end leading to increase in cost of funds. Even in India the reducing interest rate regime prevailing for the last 3 years is likely to end soon and so is the case with Government Securities (G-sec) yields.
“With hardening of interest rates and rise in G-sec yields, cap rates would see an uptick in the short term over the next 1-2 years making these assets valued lower. That can be an opportunity for investors to build new positions,” Das said.
According to Maheshwari, in a developing country like India, due to high growth — both in rental as well as capital values, the spread between cap rates and interest rates should be negative — higher interest rates as against cap rates.
While in the short-term there are many challenges for cap rate to compress further, in the long term, the strong fundamentals coupled with maturing of the Indian economy would lead to compression in cap rates, experts said.