Till 1990s, offices were largely limited to the central business districts of various cities, functioning primarily as the central node where most of the commercial activities of the city took place. However, heightened migration in the last couple of decades due to increased commercial activity, along with a saturated urban core, has resulted in development of satellite and suburban nodes. Improvements in intra-city infrastructure and connectivity have facilitated the growth and acceptance of these peripheral locations. By 2015, 61% of office space in India will be located in the suburbs.
Office vacancy in the country has grown from 5.1% recorded in 2007 to 18.2% in 2011, due to the supply overhang over demand remaining through most of the quarters. As of 2011, nearly three-fourths of the operational office space in India is built for the IT/ITES sector, and by end-2015 this share is forecast to remain the same. With power, connectivity and security specifications built-in to support IT/ITES firms, these campuses have dotted the suburban locations, providing state-of-the-art infrastructure and amenities to their tenants.
To encourage the growth of Indian IT/ITES industry, several incentives have been provided to the sector. However, there have been some recent policy changes, which will have an impact on both demand and supply of office space in India.
Sunset over tax benefits under STPI during 2011
The tax benefits under STPI through Section 10A and 10B of the Income Tax Act ended in March this year which directly affects the margins of those IT/ITES firms. Although demand for IT SEZ projcts showed traction in the last couple of quarters, the small-tomid-size firms that have low space requirements and are unwilling to invest the capital expenditure for fitouts during relocation, shall choose to operate out of STP units, and not relocate to SEZ units. The central government is considering a new incentive scheme for STP units, to promote IT/ITES development in tier II and III cities.
Direct Taxes Code in 2012
The expected implementation of the Direct Taxes Code from April 1, 2012 will make the Minimum Alternate Tax (MAT) and dividend distribution tax (DDT) applicable to SEZs, which will impact the margins for both SEZ developers as well as occupiers. Already, several SEZs have been denotified by developers, citing reasons such as the imminent economic meltdown, poor market response, non-availability of a skilled labour force, lack of demand for IT/ITES space and the impositionof MAT and DDT. There will be more denotifications of SEZ projects which have not broken ground yet or are at initial stages of construction, and this will reduce the office supply in pipeline.
Incentives may continue
Various state governments such as Andhra Pradesh, Karnataka, Maharashtra, Tamil Nadu, Uttar Pradesh (for Noida/Greater Noida) and Haryana, among others provide incentive packages for IT/ITES industry through the state IT policies. Some of the incentives are preferential allotment of land, single window/desk clearances, relaxation of FSI and zoning, reduced or exempt stamp duty and registration charges and reduced or exempt sales tax and others.
Office architecture in Indian cities has improved significantly during the last decade in terms of aesthetics, sustainability, scale and amenities that it provides to the occupiers. Common area maintenance (CAM) charges have increased considerably, both due to persistent high inflation, as well as better ex-office infrastructure within the campus. The focus is also shifting to replicate a similar growth story in tier III cities. In a bid to reduce occupancy costs, few firms are gradually increasing the employee density at work places, challenging the covention of 100 sqft per person.
Leasing in Indian office space is dominated by three industries – IT/ITES, banking, financial services and insurance (BFSI) and manufacturing. Nearly 70% of the leasing transaction volume for office space in India is contributed by foreign based firms.
The average size of office leasing transactions which was 58,260 sqft in 2007 reduced to 27,246 sqft in 2009. However, it improved from 27,246 sqft in 2009 to 35,697 sqft in 2010.
The economic outlook remains uncertain, creating a difficult operating environment for the occupiers for the next 12-15 months. Persistent high inflationary pressures along with monetary tightening by the RBI have induced liquidity constraints on the industry accompanied with rising input costs. With over 60-70% of the demand for office space contributed by the IT/ITES and BFSI sectors, the outlook of commercial office markets is extricably linked to the North American and European economies, which are facing fiscal pressures and a likely double-dip in growth. Additionally, the slowdown in residential sector is affecting the financial health of highly leveraged developers.
Seeing ominous clouds over the horizons, Indian occupiers faced with compressed revenues and margins, will tread with caution in the coming months, However, the watchful ones will move ahead and stay competitive by tapping into the incidental opportunities, which were hitherto unavailable.