The Cornerstones of Commercial Real Estate- Part 2

Welcome back! Its been a good 4 months now since we last interacted.  I'm afraid I am pretty much responsible for it. A lot has happened in these past four months, the most significant of which was Legion opening its Bangalore Office. More on that later. For now, its back to the Cornerstones of Commercial Real Estate.

Commercial Real Estate, as a fragment of the Real Estate industry, has evolved tremendously over the past two decades. Ever since 2004, the country absorbs close to 40 Million square feet every year with the major 6 cities namely Mumbai, NCR, Bengaluru, Chennai, Hyderabad and Pune accounting for as high as 90-95%. The super 6 as I’d like to call them have grown primarily owing to two reasons. The first reason is demand from occupiers/tenants, large and small; the second reason being quality and scale of Commercial Real Estate Development that enters these market every year. We have already dwelled upon the Occupiers aspect in the previous article so now let us examine the 2^nd of the Cornerstones of Commercial Real Estate i.e Developers.

Developers concern themselves with the supply side of the business. A developer’s primary external objective is to either create demand or cater to the demand that is generated by occupiers. Their business is time, risk and capital intensive. Developing a project is like synchronizing an orchestra. Every note has to be in place for the end product to appeal to the listener.  In more ways than one, they shape a city’s skyline. We would like to categorize developers in the following generic yet effective manner:

1)      The Price Makers: The price makers are generally the first movers in a particular city/area/location. They set the benchmark for other players to enter the market not just from a price perspective but also from a quality perspective. It is a known fact that almost every established location within the country was developed by Price Makers, be it Whitefield and ORR in Bangalore, OMR and Guindy in Chennai, Madhapur and Gachibowli in Hyderabad or Kharadi and Hinjewadi in Pune or DLF Gurgaon.

What makes them Price Makers in the first place? The answer is not simple. It is a combination of the following:

a)      Risk appetite : The ability to place their bets on relatively unknown locations requires a degree of risk that smaller Developers are generally incapable of taking. Price Makers do not only develop the project. In many cases, they partner with the local bodies to develop infrastructure in and around the area including Roads, Power, Water, Telecom etc. They land bank extensively and this in turn presents an ideal opportunity when they sense demand for space in the particular area

b)      Foresight: Price Takers have the foresight to determine if their risk is likely to pay off. This foresight is the result of many years of experience across diverse locations as well a keen understanding of the laws of the land. Add to this modern research and analytics and this only makes their decisions more complex.

c)      Financial Muscle: Not only does the developer require Financial muscle to see through the development of the project, many of which run into years, they also have the sustaining power to see through the idiosyncrasies of Business Cycles as well as hold onto land banks until an opportunity presents itself.

d)     Statutory Know-how: They have the know-how when it comes to obtaining approvals from the various statutory bodies. This is particularly important as many of the approvals can run into months (sometimes years). What appears to be a minor violation can snowball into something that can delay the overall project for months.

e)      Technical excellence: Having succeeded using a tried and tested formula of development that adheres to stringent Environment, Health and Safety Norms, the Price Makers have their teams in place to execute projects with remarkable ease.

f)       Right price for the right market: Price Makers have a wealth of data through primary and secondary research which enables them to determine the right price and the right product. These research reports are quite exhaustive and provide the Price Makers analyses on Demand, Supply, Absorption and Vacancy in the nearby Micro-markets along with a glimpse on the short-term as well as long-term infrastructure developments that would determine the viability of developing a project.

2. Price Takers: What we refer to as Price takers are Developers who are considerably less risk averse. They are a combination of Large and mid-size developers. Let’s deconstruct them in the same manner as we did for the Price Makers:

a)      Risk Appetite: Price takers are relatively more risk averse. They are content with following the Price Makers in the respective market. Although they may have the financial depth to sustain themselves through varying business cycles, their aversion to risk makes them less leaders and more followers.

b)      Foresight: Price Takers are quick to acknowledge the potential of a certain location however logic and conservation precede foresight and ambition. They limit the extent to which their foresight affects their decision and are more prone to be led by extensive research and analyses.

c)      Financial Muscle:  There is absolutely nothing to suggest that Price Takers do not have the same depth as Price Makers. In fact, I wouldn’t hesitate in saying that some of them have even deeper pockets by having access to international funds. They also have the sustaining power to see through multiple business cycles. Unlike Price Makers who generally implement and develop large scale projects, Price Takers can come in various sizes. They can develop Large projects (500,000 sft +)as well as Medium Projects (200,000 sft-500,000 sft).

d)     Statutory Know How:  In this aspect as well, there is little or no difference between Price Makers and Price Takers. Price Takers are very well aware of the statutory norms of a particular City/Location.

e)      Technical Excellence:  Here again, there is little or no difference between the two. Although more often than not, Price Makers are the ones that are benchmarked, Price Takers are equally capable of delivering as good if not better specifications

f)       Right Price for the Right Market:  Price Takers have a relatively shorter learning curve as they already have the benefit of observing and learning form the Price Makers experience and mostly at their cost. They are far more conservative in their pricing.

3. Price Breakers: Every market has these. They are bane of the Price Makers and the Price Takers. They enter a market with a ‘value proposition’ that is primarily driven by price and less so by quality. They are the opportunists who will not shy away from capturing market share. They are often scoffed at by their more illustrious fraternity however remain unaffected. They move swiftly and have no regard or respect for market benchmarks. How do they fit in?  Let’s take a look:

a)      Risk Appetite:  Price Breakers play to capture market share at the earliest available opportunity. As mentioned above they are opportunists. Unlike Price Makers and Price Takers their fleet-footedness allows them to develop smaller projects that may not pay as much attention to quality or detail thereby making them relatively less risky. They enter when basic infrastructure is already in place.

b)     Foresight: They are not known for their foresight. Instead, they rely on the foresight of their more illustrious counterparts. Price Breakers seldom bother themselves with foresight. They are too busy delivering low cost and low value projects. This rather annoying quality of theirs makes it difficult for the Price Makers and Price Takers to sustain their price points.

c)      Financial Muscle:  Price Breakers may be relatively smaller than Price Makers and Price Takers, but their quick turnaround time and cost effective commercials ensure that they exit their projects quickly. They do not believe in investing heavily in the overall development of a micro-market and are happy to live off the other two.

d)     Statutory Know-how: Here again, there is no real difference between all the three categories.

e)      Technical Excellence: If there ever is a chink in their armor, technical excellence is it. Price Breakers are more likely to be caught off guard when it comes to adhering to absolutely stringent Environment, Health and Safety Norms. This is not to say that they are unsafe or non-compliant. It just reflects on the fact that many of these developments will not suffice the needs of Multi-nationals and they are well aware of that. They will fulfil the minimum requirements of a building but not the optimal requirements.

f)       Right Price for the Right Market:  Price Breakers are not concerned with the market benchmarks. They price their product based on their own internal calculations and the focus is clearly on completing the project and exiting. They are very often mocked at and scoffed at by Price Makers and Price Breakers yet they remain unperturbed.

A Pictorial perspective

I do hope this article gives you some insight about Developers. They are an integral part of the three cornerstones and without them Commercial Real Estate wouldn’t exist. In the next article, we shall complete the COrnerstone series by understanding the third but by no means the least- The Investor.

Hope you have had a memorable 2014. Time to now look forward to the 2015 with gusto. All of us at Legion wish you a Merry Christmas and a happy New Year. See you all in 2015.

The Cornerstones of Commercial Real Estate: Part 1

Dear Readers,

Welcome! Over the past three and a half years there are many adjectives that can be used to describe Legion’s journey. Memorable, exhilarating, gut-wrenching, fulfilling, arduous, and passionate are just some of words that come to our mind. All along this journey, through the good and the not-so-good times, the one thing remained constant was Knowledge Gathering. And thanks to our families, some very close friends, colleagues, clients and well-wishers, we hope to make our humble contribution to the vast ocean of knowledge that exists in the field of Real Estate through this medium. True to our specialty, we will focus primarily on Commercial Real Estate (CoRe).

Like any other industry, Real Estate in our country has and continues to evolve rapidly. And within Real Estate, Commercial Real Estate has experienced some serious ebbs and flows. Over the past decade we’ve witnessed, unprecedented growth, radical drops, recession, rapid recovery, stabilization, innovation, adaptation, downfalls, and any other trend that is visible in business cycles. One things for sure though, Commercial Real Estate is here to stay.

So where do we start then? There’s just so much happening in CoRe that it makes it difficult to pinpoint any one aspect that warrants more attention than the others. In any case in order to simplify things, let’s get generic. Let’s start with the absolute three cornerstones of CoRe.

A) The Occupier

B) The Developer

and C) The Investor

Occupiers are popularly known as Tenants or End-users and are the main contributors to the demand. They come in all shapes and sizes ranging from Start-ups to massive Multi-national Corporations, from Cafés to Food court operators, from Banks to Retail Stores, from Domestic to International companies. In the Concrete Jungle, Occupiers can be categorized into three distinct types:

a)      The Elephants:  These are large companies with an enormous appetite for adding space to their ever-growing Real Estate portfolios. They include companies several Fortune 500 IT companies who outsource their Technology needs to India either through their own captive unit or through a third party. Statistics reveal that the top 20 companies account for more than 80% of the total office space absorbed in a year. Considering that India absorbs close to 35Mn sft to 40Mn sft in a single year, that number would amount to 28Mn to 30Mn. That’s a staggering number. The Elephants more often than not form the bedrock for a Developer to develop quality office space.

All Elephants have elaborate processes that are set in motion by various specialist teams that evaluate a particular project from all perceivable angles including stringent Environment, Health and Safety (EHS) Norms; Statutory compliances; Business Continuity Risks; Business Scalability; Employee Accessibility; And of course running complex Financial Models to check the viability of the project. Compliance to these norms by the Developer gives confidence with regard to the marketability of the project by bringing in relatively smaller players. Smaller, yes! Less important, No! Which brings us to our next category of occupiers i.e The Big Cats.

b)      The Big Cats:   In the natural world, the Big cats are the apex predators in the Jungle. However, in the Concrete Jungle, One can refer to companies that are powerful in terms of their presence but not necessarily in terms of size. They may be far smaller in comparison to the Elephants but they still occupy large spaces, are distinctly territorial and most importantly form a major attraction for the Developer. Mid-Size IT firms form the largest chunk in this category. Here again, they may be either Captive Units, Product Companies, Engineering and Design services, Research and Development Wings of their parent firms or third party service providers who compete in niche areas.

Decision-making in these organisations are generally centralized and quite often taken overseas. They are as elaborate as the Elephants and sometimes even more stringent. For a developer, they are the marquee names that would add a combination of quality and quantity to the IT Park.

c)      Springboks: I could use the term Deer but the South African Counterpart sounds a lot more lively. Springboks are the equivalent of Small and Medium Enterprises (SME). They aren’t all that small actually. These companies are typically the ones who have been around for a while, their growth has been steady but not feverish. They have their client bases well set and continue to survive rather than thrive. Having said that, these companies become mouth-watering propositions for the Big Cats to acquire at some point (Just like in the Jungle, the predators hunt the prey).

Springboks are harmonious in nature. They are not looking for back-breaking (from the developer’s point of view) deals. They are happy to be in a project that houses their basic needs. They don’t fall into the overly ambitious category. Mostly these are third party providers who tend to win relatively smaller contracts from the larger corporations who prefer hedging their risks.

d)      Rabbits: Rabbits are true their Natural Counterparts. They are fleet-footed, timid to an extent, and grow (read breed) quickly. They are usually the clients that ‘fill’ in smaller spaces in a particular project and are extremely price sensitive. Mostly, companies that are under 5 years old tend to fall into this category. They seldom have the negotiating power of the previous two categories however, their contribution enhances the average rentals of a particular project. Being small and flexible, these companies tend to grow into multiple locations as their business may demand before reaching a critical mass in order to consolidate.

Decision-making in Rabbits is very nuclear and sometimes even single dimensional. They are mostly entrepreneurial in nature hence requiring much less turnaround time. They are cost sensitive when it comes to investing in their interiors or ‘fitting out’ the space and tend to look for innovative means to save on their expenses.

As some of you may notice, I have generously borrowed the terms Elephants and Rabbits from my mentor and Guide Subroto Bagchi’s book The Elephant Catchers. I do hope the above article helps you gain a marginally better overview of one of the cornerstones of Commercial Real Estate.  We would love to hear from you. Drop in your feedback in the comments column below or email us @ discuss@legion.co.in. Thank you for dropping by.