The effect of coronavirus is expected to have a differential impact on the commercial real estate (CRE) sector in India. The retail commercial space comprising mainly of mall operators will be impacted in a major way due to its closure across the country whereas, in the office space segment, the repercussions are likely to be marginal. The global spread of COVID-19 since January 2020 is resulting in a slowdown in economic activity across the world. The impact on India has been limited so far, however, increasing the spread of the pandemic in the country over the last few days and the preventive measures being taken by the Central and various state governments have severely restricted business activities, the CRE segment being no exception.
Commercial real estate sector (retail)– Retail players i.e. mall operators are expected to be significantly impacted due to the mandatory closure of malls across states in the country, till April 01, 2020. Mall operators generate almost complete income from lease rentals received by the tenants. In the current circumstances, though the clauses in the lease agreements differ across properties and tenants, as per ICRA analysis, typically multiplex operators and large anchor tenants have force majeure clauses covering waiver of rentals during the closure of operations. Additionally, as the revenue streams of all the tenants will cease for the closure period, their financial position is expected to be under pressure. Rental expenses form a sizeable share of 12-16% of revenues for retailers, therefore, all tenants are likely to negotiate for waiver/rebate of the rentals. It is believed that the rental income of the mall operators will be impacted in the near future. Even after the resumption of operations, the footfalls are expected to be muted, therefore, the financial position of the tenants will continue to be stressed. Resultantly, the rental income of the mall operators, which also comprises a portion of the revenue share, is expected to gradually ramp up over the next few months.
According to Mr. Anand Kulkarni, Assistant Vice President and Associate Head – Corporate Ratings, ICRA: “ We believe that though the debt-servicing ability of the mall operators may come under stress in the near term, the presence of liquidity buffers i.e. debt service reserve accounts (DSRA) in the form of free cash, liquid investments, fixed deposits will play a significant role in managing the crisis. Entities with strong parent support and financial flexibility will also be able to mitigate the near-term risks more effectively.”
Portfolio impact: ICRA assumes that the mall operators will not receive the rentals (minimum guarantee as well as revenue share) during the closure period. Footfalls are expected to be subdued after mall opening and hence the rental receipts might be delayed as well as curtailed. As a base case, the closure period is expected to be around one month followed by weak footfall for an extended period. In this case, around 45% of the rated mall portfoliois likely to be vulnerable. Entities with limited or no liquidity buffers as well as entities with low credit rating having ordinary financial flexibility also might be impacted. In an optimistic scenario, wherein the mall operations resume after around 15 days of closure followed by a gradual improvement in footfalls, around 21% of the portfolio will face vulnerability. In a stretch case scenario, wherein the closure extends beyond two months, the impact will be much larger, at around 62% of the rated portfolio. ICRA believes that the strong promoter group will continue to support the group entities with a timely infusion of liquidity and hence they will be better placed to withstand the crisis. Though many of the companies in the rated portfolio have the DSRA in place, equivalent to one to three months of debt-servicing requirements, timely utilization of the same by the lenders in case of the shortfall will remain critical to avert any rating action due to delays in debt servicing as per contractual terms.
These assumptions are based on market understanding and feedback from participants; however, the estimates are subject to change considering the uncertainty due to the significant and rapidly changing situation. ICRA will continue to monitor the situation for various parameters like settlement between mall operators and tenants regarding rental waiver, timeliness of collections over the next two months and any policy level support from the Government.
Commercial real estate sector (office) – ICRA believes that the impact on office space real estate players will be marginal. Some of the states have already enforced closure of offices while many others have strongly advised the same; however, in contrast to the retail players, the revenue impact for office space tenants due to closure of office spaces is expected to be limited. Furthermore, rental expenses form a comparatively smaller proportion of the total cost structure of office space tenants. The rental expenses typically form 1-2.5% of the revenues of the office space tenants. Better technological support has enabled a large number of office tenants to provide work-from-home facilities to employees and hence operational disruption is expected to be limited.
Nevertheless, the rating agency believes that new leasing discussions are getting significantly impacted and the situation is likely to continue in Q1 FY2021. Therefore, the ramp-up of leasing for sub-optimally occupied and recently completed properties will get delayed. In case of an extended shutdown or subdued economic activity, the properties with weak counterparties may experience delays in rental receipts. Additionally, operational difficulties and administrative issues like curtailed movements, impacted bank operations, unavailability of signing authorities may also delay the rental receipts. Hence, ICRA believes that even though the probability of lost revenue is low for office space players, the presence of liquidity buffers will remain critical to sail through the possible cash flow mismatches.
Further, there could be a re-evaluation of long-term office space planning by companies to tackle such exigencies in the future. ICRA will continue to monitor the portfolio for vulnerabilities on a case-to-case basis.
The co-working spaces segment is likely to experience a comparatively higher impact as the tenants typically are start-ups or smaller and financially weaker entities. These tenants would prefer to negotiate on the rental payments as the share of rental expenses is typically higher for them than a normal office space. Due to the ongoing crisis, the agreements between the co-working space operators and tenants may also undergo changes, thus shortening the tenures or seeking more flexibility. The probability of delays in rental receipts in co-working spaces might be higher over the next few months, considering weak counterparties. Structurally, the co-working space operators might face challenges going forward in case a sizeable number of target clients get habitual to the work-for-home set-ups and hence the overall demand decelerates. Possible changes in lease agreements like a preference for extremely short-term agreements (ranging in few days) against the current practice of monthly or quarterly agreements may also force the co-working spaces to re-strategize their operations.
“Notwithstanding the short-term disruption, we believe that the commercial real estate sector will continue to attract adequate interest from investors and tenants alike in the medium to long term. ICRA, at present, does not foresee any structural change in the office space segment due to the ongoing COVID-19 induced crisis,” added Mr. Kulkarni.
ICRA has considered a portfolio of 29
entities having operational malls across various geographies in India
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