Corporate Real

Estate and the

Decision to
Lease or Buy
 Advance - Corporate Real Estate and the Decision to Lease or Buy
 Advance - Corporate Real Estate and the Decision to Lease or Buy 

Restructuring of operations / maintenance to eventual disposal.

Various functions of the CRE executives include
Corporate Real Estate Lease Administration, Transaction Management,

(CRE) Change Management, Location Strategies,

Real Estate forms a significant portion of
operational costs for corporations today, probably
second only to human resources. The complex
and extensive data ecosystem of the real estate
portfolio makes it imperative to track and analyse.
As a result, Corporate Real Estate (CRE)
executives have increasingly assumed a greater
role in the management of real assets (land and
facilities) in the past decade. Corporations are
actively increasing financial flexibility utilizing
the new-age workplace management systems
to manage real assets and reduce fixed costs.
With increasing transparency in the market, CRE
executives are equipped with better knowledge
of the physical and financial indicators. CRE
Management is being integrated at multiple points
of a project lifecycle, right from its lease / buy and
Portfolio Management and Facilities Management.
Rapidly changing business environments during
the expansion phase of Indian economy during
2005-2008 led CRE executives to position
flexibility at the core of future real estate decisions.
As a result, shadow capacities were generated
across industries. The recent slowdown has laid
emphasis on the efficient minimization of these
shadow spaces. As a result, several relocation,
consolidation and decentralisation initiatives of
office space were witnessed across cities in India
during 2H08-1H10 (Figure 1). The search for
cost efficient real estate portfolio was helped by
the confluence of correction in rental and capital
values along with the huge expected supply in the
secondary and suburban business districts.

Figure 1: Portfolio Restructuring Strategies Adopted During the Slowdown (2H08-1H10)

Strategy Process Synergised Benefits

Relocation provides the essential benefit of reduced real
Relocating to a location with
EX N Relocation estate costs by leasing or buying space of adequate size and
reduced real estate costs
specifications at a possibly reduced property rate.

EX
EX EX
Consolidated centralisation is motivated by the synergy of
economies of scale achieved by operating out of a single office.
N
Consolidated Consolidating multiple offices to
It helps in reducing real estate costs by merging functions
Centralisation a single location
and reducing shadow capacities lying idle at multiple existing
EX EX locations.
EX

N
Functional decentralisation helps in reducing real estate costs
EX EX Consolidating multiple offices
Functional by distributing the non-essential functions of a business to
or splitting a single office to
Decentralisation less expensive real estate locations while retaining or moving
multiple locations
EX essential functions to a prime location.
N EX

EX N Expansion provides the opportunity of augmenting operations by

Expansion Expanding to new locations
leasing or buying additional real estate space.

EX – Existing Locations | N – New Locations

Source: Real Estate Intelligence Service (JLL)
1
Indian Tier I and II cities climbed to composite ranks 41 and 49 respectively, positioning themselves in the Semi-Transparent segment in Jones Lang LaSalle’s Real Estate Transparency Index 2010.
Read our research publication – Mapping the World of Transparency – Uncertainty and Risk in Real Estate released in 2010.
 Advance - Corporate Real Estate and the Decision to Lease or Buy

Figure 1: Portfolio Restructuring Strategies Adopted During the Slowdown (2H08-1H10)

Leasable / Saleable
City Buyer / Lessee Year Lease / Buy Strategy
Area (sq ft)
Hyderabad Tata Consultancy Services 2010 180,322 Lease Expansion
Chennai Cybernet Slash Support 2010 128,000 Lease Consolidated Centralisation
Chennai Marg Constructions 2010 116,800 Lease Consolidated Centralisation
Bangalore Citrix 2010 127,000 Lease Expansion
Bangalore Sony 2010 130,000 Lease Consolidated Centralisation
Hyderabad Accenture 2010 103,000 Lease Expansion
Noida ACS 2010 102,000 Lease Relocation
Hyderabad Synopsis 2010 61,990 Lease Consolidated Centralisation
Hyderabad DST 2010 55,000 Lease Consolidated Centralisation
Chennai Tata Teleservices 2010 75,000 Buy Relocation
Mumbai Ernst & Young 2009 160,000 Lease Functional Decentralisation
Kolkata McNally Bharat 2009 123,000 Lease Consolidated Centralisation
Hyderabad Colruyt 2009 100,000 Buy Consolidated Centralisation
Noida Samsung 2009 66,000 Lease Functional Decentralisation
Kolkata M Junction 2009 62,000 Buy Consolidated Centralisation
Mumbai Deutsche Bank 2009 187,000 Lease Consolidated Centralisation
Gurgaon Capital IQ 2009 50,000 Lease Relocation
Mumbai ICICI Prudential 2009 41,000 Lease Functional Decentralisation
Mumbai Standard Chartered Bank 2008 220,000 Buy Consolidated Centralisation
Bangalore Delphi 2008 90,000 Lease Consolidated Centralisation
Bangalore LSI Logic 2008 277,000 Lease Consolidated Centralisation
Hyderabad Brigade 2008 60,000 Buy Consolidated Centralisation

Source: Real Estate Intelligence Service (JLL)

 Advance - Corporate Real Estate and the Decision to Lease or Buy 

The Decision to Figure 3: Transactions Done by Various Industry Verticals During 2H08 – 1H10
Sale Transactions
Lease or Buy Others IT/ITES
Faced with the prospect of new transactions, 10% 1%
corporate real estate (CRE) managers have been Pharmaceuticals
analyzing the options of leasing versus buying a 8%

real estate space. In the recent slowdown, distinct Telecommunications

trends have emerged among industry verticals 7%
while strategically choosing either to lease or buy Services
real estate space (Figure 3). While the IT/ITES 4%

sector has been the frontrunner in terms of

BFSI
lease transactions recorded during 2H08-1H10, 41%
Manufacturing /
accounting for 41% of the total lease transactions,
Industrial
BFSI and Manufacturing / Industrial sectors have 18%
been dominant purchasers of office space during
Lease Transactions
the same period. The Pharmaceutical companies
Others
have a larger share of 8% in sale transactions,
8%
Pharmaceuticals
compared to only 2% in the recorded lease
2%
transactions. The Telecommunication companies
Telecommunications
have equitable share in both sale and lease 8%
transactions, accounting for 7-8% of the total IT & ITES
Services 41%
transactions recorded during the period.
9%

The variation in the decision pertaining to lease

or buy is not without reasoning. The underlying Manufacturing /
principle in the analysis is that the firms are Industrial
1%
generally focussed on their core businesses and
not in the properties they own or lease. However, BFSI
the degree of control of occupied space has far- 0%

reaching strategic implications for its occupiers. Source: Real Estate Intelligence Service (JLL), 2Q10
Hence, certain industries and corporate prefer Note: The analysis represents 91 sale transactions and 911 lease transactions by occupiers of investment
grade office space recorded during 2H08 to 1H10. The transactions were recorded in the top seven cities of
either leasing or buying a real estate space. India by population size – NCR-Delhi, Mumbai, Kolkata, Bangalore, Chennai, Hyderabad and Pune.
 Advance - Corporate Real Estate and the Decision to Lease or Buy

In this paper, we discuss the implications of a

decision of leasing versus buying a corporate
real estate (CRE) space. As such, the decision
pertaining to lease or buy involves the financial
analysis of comparing the cash flows of these
two options and beyond. An important aspect in
financial analysis is to gauge the trends of capital
values and rental values of the subject property
and estimate its impact on cash flows for the
holding period during which the tenant intends to
occupy the property. The strategist needs to have
a keen grasp on the status of the markets being
undervalued or overvalued and the yields offered
in the market. Also, it requires diligent real estate
market analysis not only at the macro level but
also at the project level.

Figure 4: The Decision to Lease or Buy

Decision To Lease Or Buy

The procedural components of lease-versus-buy decision making

discussed in the paper are

● TACT – Tactical Analysis of CRE Transactions; and

● FACT – Financial Analysis of CRE Transactions; supported by
● REACT – Real Estate Analysis of CRE Transactions.

The final decision is influenced by the result of the three components and
can’t be taken solely on the basis of any single model. While TACT is
sufficient for an initial screening, FACT is essential to ensure that the best
options have been studied in detail.

Source: Real Estate Intelligence Service (JLL)

Tactical Analysis of CRE Transactions
(TACT)
TACT begins with the decision to restructure the
real estate portfolio by expansion, consolidation
or downsizing. Parameters such as nature of
operations of the company, requirements of
size, operational flexibility, degree of control and
duration of use are evaluated for leasing versus
Financial Analysis of CRE Transactions
(FACT)
FACT entails a financial analysis of the
alternatives of leasing and buying available in
the current real estate scenario. Two primary
methods are used to evaluate the projected cash
flows over the intended holding period.
● Net Present Value Method
Real Estate Analysis of CRE Transactions
(REACT)
REACT encompasses the various real estate
considerations, which feed both analytical tools
- TACT and FACT with the state of the real
estate market along with available transaction
opportunities.
● Evaluation of phase of the market as bring

buying. Key tactical considerations are - ● Internal Rate of Return Method undervalued or overvalued
● Operational Flexibility ● Exploring alternatives available at a desired

● Management Control Further, scenario and sensitivity analysis is yield

● Initial Capital Outlay done with several parameters such as expected ● Timing the market on the property clock

● Benefits of Positive Leverage residual value, cost of capital, forecasted rental

● Equity Build-up movement and initial rental yield to arrive at
● Tax Shield inflexion points of a lease versus buy analysis.
● Required Specialisation of Managing

Real Estate
 Advance - Corporate Real Estate and the Decision to Lease or Buy 

TACT – Tactical Analysis of CRE Transactions

Leasing for commercial real estate occupiers is a means to assume physical control and to reap a partial economic benefit from commercial
space without obtaining an ownership interest in a property. On the other hand, buying is a means of obtaining the full economic benefit of
a property including cash flows from the property, the capital appreciation and its physical use. Transaction value for leasing is significantly
lower than buying and hence may have a significant effect on occupiers’ balance sheet. Also, most buyers usually acquire property
through the use of equity and debt financing which has a financial impact on their debt ratios and cost of capital. Depending on the tactical
considerations of a company to extract synergy from CRE transactions, the company will do a preliminary analysis of a buy versus lease
transaction (Figure 5).

Figure 5: Tactical Considerations of Leasing versus Buying

LEASING BUYING
Operational Flexibility: In terms of expansion, contraction and relocation High Low
Leasing provides a higher operational flexibility over ownership in terms of expansion, contraction and relocation. However, restrictive term clauses restrict
this flexibility to some extent. In India, typical lease terms are for 9 years (3+3+3 years or 5+4 years). The operational flexibility to relocate and adapt to
suitable space requirements is essential in rapidly changing business environments.
Management Control: In terms of space remodelling, occupiers profile, common areas Low High
Buying provides a better management control over the property in terms of adaptive remodelling of space to suit business requirements, occupiers’ profile
and use of common areas.
Initial Capital Outlay: Including costs of purchasing and leasing Low High
Leasing typically requires a lower initial capital outlay than owning and hence is preferred by high growth organizations which would like to invest in their
core business. Buying incurs a significantly higher initial outlay and hence buyer should have established sources of financing, either through utilization of
cash reserves, debt, equity or mezzanine financing.
Benefits of Positive Leverage: Due to higher yield obtained on an leveraged investment Low High
If buying is financed using debt, the buyer is benefited by positive leverage due to higher yield obtained on a leveraged investment than that obtained on
an unleveraged investment. However, high leverage increases risks in the case of poor performance of the business.
Equity Build-up: Gain from capital appreciation Not Available Available
Real estate properties have typically appreciated in capital value over a longer duration. While leasing shields the lessee from the downside risk of capital
erosion, the gains from capital appreciation is available to the buyer. However, appreciating assets carried at book value might attract corporate raiders
towards buyers who own real estate assets.
Occupancy costs fully Operating expenses,
Tax Shield: Due to occupancy costs tax deductible and hence depreciation and interest
higher tax shield tax deductible
Occupancy costs are fully tax deductible for leases and hence provide a higher tax shield. Operating expenses, depreciation and interest are tax
deductible in the case of ownership. Accelerated depreciation methods allow for the depreciation of the commercial property with greater deductions in the
property’s early years. A sale of property at the end of the period results in tax payment on sale price and book value differential.
Required Specialisation of Managing Real Estate: In issues like legal compliance, health
Low High
and safety, market risks and other such issues not related to companies’ core business
As the core business of the firms is not focused on the properties they own or lease, owners typically require an additional specialisation of managing real
estate. The inexperience of managing real estate might result in high incidental costs.
Source: Real Estate Intelligence Service (JLL)
Note: The boxes marked in green provide a tactical advantage and those marked in red provide a tactical disadvantage for the related strategy.
 Advance - Corporate Real Estate and the Decision to Lease or Buy

FACT - Financial Analysis of CRE Transactions

Figure 6: Steps in Financial Analysis of CRE Transactions

STEP 1 – Determine the Initial Capital Outlay and Periodic Costs

Apart from the purchase value and fit-out costs, the initial capital outlay includes the purchase costs in the case of buying. Periodic costs will
BUY

include costs of managing and maintaining the property.

Initial outlay in the case of leasing includes the deposit, the prevalent monthly rent and leasing costs. A rental index based on prevalent rental
LEASE

escalation clause or expected rental growth is used to assess periodic rental expense and maintenance.

STEP 2 – Determine the Residual Value

Residual value is dependent on expected change in capital value over the holding period. Selling costs are factored to arrive at a net residual
BUY

value.

STEP 3 – Examine the Depreciation and Tax Implications

Based on the factors involved in the NPV and IRR analysis, the two most important factors are treatment of depreciation and tax benefits. Under
the Income Tax Act and the Indian Companies Act, commercial space occupiers are eligible for depreciation allowances. Overall depreciation
depends on the purchase value of the property, which has three components – real estate cost, cost of plant and machinery and the fit-out costs.
All these components are treated differently for depreciation purposes.
BUY

Interest on the debt taken for buying commercial space is deductible for tax calculation purposes (corporate tax in India is 33.9%).
At the end of the holding period, if the owner wants to exit the property, his realization would be subject to long term capital gains tax which stands
at 22.6% in India for Long Term Capital Assets i.e. property held for a period of 36 months or more. The asset disposal also considers depreciation
recapture, which is the procedure for collecting income tax on a gain realized by a taxpayer when the taxpayer disposes of an asset that had
previously provided an offset to ordinary income for the taxpayer through depreciation.
LEASE

Occupancy costs are eligible for tax deductions in the case of leasing.

STEP 4 – Perform a Comprehensive Cash Flow Analysis

Based on the cash flow generated by STEP 1 through 4, a comprehensive cash flow analysis is done using the two methods – Net Present Value
(NPV) & Internal Rate of Return (IRR).
1. Net Present Value (NPV) Method – entails comparison of NPV of both the alternatives at the specified rate of discounting which reflects the
BOTH

occupier’s cost of fund and selecting the alternative with a higher net present value.
2. Internal Rate of Return (IRR) Method – estimates IRR for the differential of the cash flows of the two alternatives, namely buying and leasing. If
this IRR is greater than the opportunity cost of capital for the occupier, buying is preferred over leasing.

STEP 5 – Perform Sensitivity and Scenario Analysis

Scenario and sensitivity analysis is done with several parameters such as expected residual value, cost of capital, forecasted rental movement and
BOTH

initial rental yield to arrive at inflexion points of a lease versus buy analysis.

Perspectives

2010

Lifting Your Game: Scenario Planning for Real Estate

Numerous corporate real estate (CRE) executives were caught by surprise with the speed of economic deterioration in
2009. It is not improbable to think that many will again be surprised, this time by the speed of recovery – at least in the Asia
Read our research publication – Lifting Your Game: Scenario Planning for Real Estate released in 2010
Pacific region. The volatility faced by many large corporations has also raised questions about the level of preparedness of
CRE executives to respond to sudden shifts in markets.

Scenario planning should not be confused with the more

“We can’t solve problems by using the same kind of thinking
common best-case-worst-case approach, where only a
we used when we created them.”
limited number of variables are changed in each case. Once

- Albert Einstein
The concept of scenario planning has been a key element in
the deployment of military strategies such as those described
in Sun Tzu’s Art of War. In the past decade or so, this has
also been used widely in the conceptualization of organization
strategies. Scenario planning can be adapted to be a tool that
Emphasizing on the need for CRE executives to use scenario analysis in their assessment of real estate strategies, the
the analysis involves multi-variant and multi-dimensional
considerations, the definition of each of the worst and best
cases becomes blurred, and the approach is technically no
longer robust (Fig 1).
While the best-case-worst-case approach typically works well
for short-term planning, scenario planning is a far more flexible

paper elaborates on the various steps in Real Estate Scenario Planning (RESP) process – Seek, Synthesize, Storyboard
approach that supports a longer strategic planning horizon and
CRE executives can use to take strategic portfolio planning one can accommodate a greater number of uncertainties and/or
step further. unforeseen events (Fig 2).

Fig 1: Challenging the Best-Case-Worst-Case Approach Fig 2: Scenario Planning: A Powerful Approach to Navigate

and Strategize.
the Future
Base assumptions Additional factors 1 year Planning Horizon 10 years

• Sales +50% • New sales office rollout

• Headcount +30% • Improve workspace Limited Multiple
Best

• Space utilization ratio technology provision for Variables Variables

(no change) sales staff
• Real estate spend +30%

Limited Multiple
• Sales +10% • Implement alternative Does the Dimension Dimension
• Headcount (no change) workplace solutions to best-case- Best-Case- Scenario
• Space utilization ratio -10% of space Planning
Base

worst-case Worst-Case
(no change) • Leverage market to Approach Approach
• Real estate spend reduce learning costs relationship
still hold? High Degree of Rife with
(no change)
Certainty Uncertainty

• Sales -5% • Implement alternative

• Headcount (no change) workplace solutions to
Worst

• Space utilization ratio -20% of space Limited Address Risk is Key Input
-10% • Good opportunity to own of Risk to Strategy
• Real estate spend -30% 10% of portfolio

Low Complexity High

Source: Jones Lang LaSalle Source: Jones Lang LaSalle

 Advance - Corporate Real Estate and the Decision to Lease or Buy 

Figure 7: Leasing versus Buying of Properties versus Investing in Core Business

Assuming No Capital Appreciation, No Depreciation Allowances and Discarding the Growth Phase of Company
Assuming no capital appreciation, no depreciation allowances on the subject property and discarding the growth phase of the company, the above
analysis can be simplified into scenarios which involves comparison of rental yield (RY) with the weighted average cost of capital (WACC) and return on
capital employed (ROCE) in the core business. Rental yield is the average annual rental income achievable over the holding period divided by the capital
value of the subject property.

If rental yield is greater than weighted average cost of capital, then leasing is costlier than buying and hence buying the commercial space should be
preferred. Conversely, if rental yield is lower than weighted average cost of capital, then buying is costlier than leasing and hence buying the commercial
space should be avoided.
Scenario 1: WACC<RY<ROCE

In this case, since weighted average cost of capital is lower than property yields, buying the commercial space should be preferred. However, the
return on capital employed in core business is higher than property yields reflecting that core business provides more returns than property and hence
investment in the core business should be preferred. In such cases, if availability of funds is limited or cash reserves are not sufficient, investment in the
core business and leasing the property is the most efficient option. However, if ample sources of funds are available; the company should invest in the
core business as well as buy the commercial space.
Scenario 2: WACC<ROCE<RY

Since property yield is higher than return on capital employed in the core business and hence buying the commercial space should be preferred over
investment in the core business.
Scenario 3: ROCE<WACC<RY

In this scenario, the company should buy the property and should not invest in the core business. It is because return on capital employed in core
business is lower than weighted average cost of capital for the company and rental yield in property investment is higher than WACC.
Scenario 4: ROCE<RY<WACC

Since weighted average cost of capital is higher than return on capital employed in the core business and rental yield on property investment, the
company should lease the commercial space, not invest in their core business and attempt to reduce the WACC by retiring debt or purchasing equity in
this scenario.
Scenario 5: RY<WACC<ROCE

In this scenario, as return on capital employed in the core business is higher than weighted average cost of capital and rental yield in property investment
is lower than that, the company should invest in their core business and should prefer leasing the property over buying it.
10 Advance - Corporate Real Estate and the Decision to Lease or Buy

Figure 8: Lease vs Buy Scenario Analysis

Model Assumptions
Area Rates
Leasable Area 150,000 sq ft Cost of Capital (Discount Rate) Variable %
Land Area 100,000 sq ft Residual Discount Rate Cost of Capital + 0.5% %
Price Cost of Debt (Govt Bond + Spread) 8.0% %
Purchase Price (includes land) 2,400,000,000 INR Assumed Tax Rate 33.9% %
Land Value 4,000 psq ft Long Term Capital Gains Tax 22.6% %
Term Leverage
Holding Period 9 years Unleveraged
Building Depreciation Life 40 years

Analysis 1: Sensitivity Analysis of Desired Sensitivity Analysis of Desired Initial Gross Yield
Yield by Varying Cost of Capital and Increase Expected Percentage Annual Increase in Capital Value / Rental Value
in Capital Value / Rental Value (assuming equal
0% 3% 5% 7%
change in both indicators) 13.9% 8.5% 6.5% 4.3%
14.0%
Cost of Capital
14.5% 14.1% 8.9% 6.8% 4.7%
The decision to lease or buy has an inflexion point (Discount Rate)
15.0% 14.4% 9.2% 7.2% 5.1%
where Net Present Value of Cash Flows for buying
15.5% 14.7% 9.5% 7.5% 5.4%
is equal to leasing. If we change parameters from
this inflexion point, the financial decision changes 16.0% 15.0% 9.9% 7.9% 5.8%

towards either buying or leasing depending on the Buy (Lease) decision above (below) the mentioned Initial Gross Yield

higher NPV. After Tax Net Advantage to Buy = (After Tax NPV of Buy – After Tax NPV of Lease)
In this analysis, a firm, with a cost of capital of Expected Percentage Annual Increase in Capital Value / Rental Value
15.5% should buy (sell) a property providing an 0% 1% 3% 5% 7%
initial gross yield above (below) 9.5% in a market
Cost of 14.0% (286,410,902) 49,801,739 267,309,095 516,063,318 800,215,668
which is expected to witness an annual increase of
Capital 14.5% (312,057,064) 15,410,811 227,615,741 470,264,475 747,399,102
3% in capital and rental values. (Discount
Rate) 15.0% (336,917,115) (17,938,444) 189,113,814 425,830,085 696,146,490
Analysis 2: NPV Analysis of Cost of Capital 15.5% (361,015,465) (50,278,675) 151,765,941 382,717,305 646,408,665
and Increase in Capital Value / Rental Value
16.0% (384,375,694) (81,641,407) 115,536,032 340,884,761 598,138,154
(Keeping Initial Gross Yield constant at 11%)

The decision to buy gets stronger with higher

expected increase in rental and capital values
and weaker with increase in cost of capital. While
higher increase in capital values will result in a
higher residual value, higher increase in rental
values will result in a larger rental expense.
Similarly, other models can be built to assess the
variation of a lease versus buy decision.
 Advance - Corporate Real Estate and the Decision to Lease or Buy 11

REACT – Real Estate Analysis of CRE Transactions

Undervalued and Overvalued Phase of Office Markets
Undervalued phase supports buying and overvalued phase supports leasing

As both capital values and rental values are the
financial indicators of the same market (basket
of properties), their relative movement gives an
indicator of the status of the prevalent rates.
Capital value behaves as a leading indicator
and the lag of growth between the two indicators
defines the market conditions to be undervalued or
overvalued at certain periods of time.
Commercial office markets in India were
overvalued in 2Q08 relative to rental appreciation
in the rapid growth phase of Indian real estate.
The appreciation of average capital values
had overshot the growth in rental values in
most of the micro-markets during 4Q04-2Q08
resulting in a rapid compression of rental yields
(Figure 9). The improved confidence in real
estate as an investment class was boosted by
continually decreasing vacancy levels, increasing
transparency, better execution capabilities of
developers and favourable policy changes. While
office vacancy decreased from 10.4% at end-2004
to 6.0% in 2Q08, ensuing policy changes with
impetus to foreign direct investment along with IT
Parks and Special Economic Zones (SEZs) helped
by an active participation of International Property
Consultants (IPCs) improved market transparency.

Figure 9: Average Change in Rental and Capital Values

2Q08 – Overvalued 2Q10 – Undervalued

300% 0
% Increase in CV % Decline in CV
smaller than greater than
250% % Increase in RV % Decline in RV -10%
%RV Change (4Q04-2Q08)

%RV Change (2Q08-2Q10)

200% -20%

150% -30%

100% -40%

50% % Increase in CV % Decline in CV 50%

greater than smaller than
% Increase in RV % Decline in RV
0 -60%
0 50% 100% 150% 200% 250% 300% -60% -50% -40% -30% -20% -10% 0
%CV Change (4Q04-2Q08) %CV Change (2Q08-2Q10)
Percentage growth of capital values more than rental values Percentage decline in capital values more than rental values

Source: Real Estate Intelligence Service, 2Q10

Note: Each point represents the rental value and corresponding capital value change in a particular micro-market over the relevant period

The tide turned in 2H08, when the perceived
risk started to increase in the sector on accounts
of falling absorption levels which projected an
imminent oversupply of office space. As of 2Q10,
a majority of the commercial markets in India
are undervalued relative to rental decline implied
by a greater decline in capital values than rental
values during 2Q08-2Q10 (Figure 9). With this
fundamental attribute favouring purchase of
office properties, a rise in the share of outright
purchases has been witnessed in the Indian
market. While sale transactions were 4.2% of the
total transactions recorded in 1H08, their share in
total transactions have increased to 11-15% during
1H09-1H10 (Figure 10).
12 Advance - Corporate Real Estate and the Decision to Lease or Buy

Figure 10: Share of Sale Transactions in Total Recorded Transactions (1H08-1H10)

100% 14.9% 16%

90% 14%

%Sale Transactions in Total

80%
Sale / Lease Transactions

13.0% 1%
70%
11.4% 10%
60%
50% 9.0% 8%
40% 6%
0%
4%
0% 4.2%
10% 2%

0% 0%
1H08 H08 1H09 2H09 1H10
Lease Transactions Sale Transactions
% Sale Transactions in Total Transactions

Source: Real Estate Intelligence Service (JLL), 2Q10

Note: The recorded transactions are owner occupied lease and sale transactions recorded during 1H08-1H10.

Towards the Desired Yield Figure 11: Average Initial Effective Rental Yields in Office Markets
High yield supports buying, Low yield
supports leasing
YIELD
PEAK
Average Initial Rental Yield = Rental Income / Capital Value

YIELD YIELD
Due to the perceived risk of oversupply and wilting 12.0%
COMPRESSION FORECAST
demand, average initial effective rental yields in
11.5%
Indian markets expanded sharply from 10.3% in
2Q08 to peak yields of 11.4% in 1Q09 (Figure 11). 11.0% Suburbs
Although rental values were declining in 1H09, SBD
10.5%
capital values had hit a floor and stabilised. The Spread
70-80 bps
‘floor effect’ was due to the reluctance of landlords 10.0%
CBD
to sell below break-even price despite taking
a short-term view on rental values. This was 9.5%

accompanied by enhanced channels of financing

9.0%
for real estate developments , including Qualified
4Q10F

Q11F

4Q11F

Q1F

4Q12F
Q07

4Q07

Q08

4Q08

2Q09

4Q09

Q10

Institutional Placement (QIP), restructuring of bank

loans, External Commercial Borrowing (ECB) and
Foreign Direct Investment (FDI), which reduced
the financial distress of real estate developers.
During 2Q09 – 4Q09, average capital values were
either falling at a slower rate than the decline in
average rental values or were stable, which led to
compression of yields. In 1H10, while rental values
hit bottom and stabilised, capital values started
strengthening in selected markets, resulting
in further yield compression. As of 2Q10, the
recorded average initial effective yield in office
markets is 10.6%.
CBDs SBDs Suburbs India
Source: Real Estate Intelligence Service (JLL), 2Q10
Note: Initial Effective Rental Yield is the initial effective rental income (after deducting outgoings such
as property tax and considering incentives such as rent free period) at the time of sale or transaction,
expressed as a percentage of the sale price or valuation. The average yield is the imputed yield of average
effective rental income and average capital values of NCR-Delhi, Mumbai, Bangalore, Chennai, Pune,
Hyderabad and Kolkata.
2
Initial Effective Rental Yield is the initial effective rental income (after deducting outgoings such as property
tax and considering incentives such as rent free period) at the time of sale or transaction, expressed as a
percentage of the sale price or valuation.
3
Read our research publication – Emerging Trends in Real Estate Finance released in 2009
 Advance - Corporate Real Estate and the Decision to Lease or Buy 13

The recorded spread of 70 – 80 bps between the Figure 12: Vacancy in Office Markets
yields of Central Business Districts (CBD) and
those of Secondary Business Districts (SBD) and

VACANCY

VACANCY
TROUGH

PEAK
Suburbs exists due to the risks of a huge supply
overhang expected in the secondary and suburban VACANCY VACANCY
35.0%
EXPANSION FORECAST
locations. While vacancy in the SBDs would peak
30.0% Suburbs
at 17.8% in 2011, that in Suburbs will peak at
32.7% (Figure 12). With minimal expected supply, 25.0%

Vacancy (%)
vacancy in CBDs will peak at 8.4% in 2010 itself. 20.0%
This differential in expected vacancy levels will
15.0%
influence the movement of valuations in various SBD

locations of a city. The initial yields in CBDs are 10.0%

expected to compress more than the secondary 5.0% CBD

and suburban markets.
0.0%

4Q10F

Q11F

4Q11F

Q1F

4Q12F
Timing the Property Clock
Q07

4Q07

Q08

4Q08

2Q09

4Q09

Q10
Cyclical low supports both - buying or leasing.
CBDs SBDs Suburbs India
However, since buying a real estate property
is typically for a longer holding period, cyclical Source: Real Estate Intelligence Service (JLL), 2Q10
Note: The vacancy is the aggregated vacancy of office markets in NCR-Delhi, Mumbai, Bangalore, Chennai,
peak discourages buying and supports short Pune, Hyderabad and Kolkata.
term leasing with re-negotiation clauses.
Figure 13: Lag between Recovery of Wider Economy and Office Fundamentals
Macro-economic fundamentals have improved
globally since the turn in 2009, with the emerging
PROPERTY VALUES

PROPERTY VALUES

economies of India and China leading the

TROUGH OF
PEAK OF
GDP GROWTH

GDP GROWTH
TROUGH OF

recovery, treading a growth path stronger than

PEAK OF

what was expected at the beginning of the FORECAST

downturn. Numerous indicators, including GDP 50 12.5
growth, Index of Industrial Production (IIP) and
Office Property Value Index (1Q05 = 100)

Purchasing Manager’s Index (PMI), point to 00 10.0

% Change in GDP (Y-o-Y)

strengthening economic conditions in India.

Tracked Quarterly

150 7.5
The effect of the economic slowdown on corporate
real estate fundamentals in India was witnessed 100 5.0
at a lag of 3-4 quarters during 2008 (Figure 13).
While macro-economic Indicators started slowing 50 2.5

at the end of 2007, office rents, which were

growing at a slow pace, started falling only by 0 0.0
4Q05

4Q06

4Q07

4Q08

4Q09
Q05

Q06

Q07

Q08

Q09

Q10
4Q10F
Q11F
4Q11F
Q1F
4Q12F

3Q-4Q08. Based on empirical data from history

of global real estate markets, which suggest a
Office Property Value Index Change in GDP at Market Prices
lag between recovery of wider economy and real
estate fundamentals, a similar trend is expected Source: Office Property Value Index – Real Estate Intelligence Service (JLL), 2Q10
GDP at Market Prices – Global Insight, July 2010
for recovery of real estate market as well. While Note: Property value index is the average index for the seven metropolitan cities of India – NCR-Delhi,
the wider economy in India has been set on a Mumbai, Bangalore, Chennai, Hyderabad, Kolkata and Pune
northward direction since end-2008, real estate
fundamentals have been treading a slow phase of
consolidation.
14 Advance - Corporate Real Estate and the Decision to Lease or Buy

Nearing the peak in 1H08, the Indian markets Figure 14: Office Property Clock and the Strategic Window of Opportunity
were in the ‘growth slowing’ quadrant of the
property clock, when rental values were increasing NCR Delhi
at a slower rate than previous quarters. As 2Q08 Mumbai 2Q09
Kolkata
demand wilted and the pressure of oversupply Bangalore
GROWTH VALUE
loomed, the markets rapidly moved to the ‘value Chennai
SLOWING DECLINING
declining’ quadrant by end-2008. By 2Q09, the Hyderabad Hyderabad
& Kolkata
rental values had corrected by 30-40% of their
Chennai
peaks and had already moved to ‘decline slowing’ Pune
quadrant (Figure 14). Bangalore
VALUE DECLINE NCR Delhi
RISING SLOWING Mumbai
The effect of strengthening absorption of office
Kolkata
space in the past 3-4 quarters has already resulted
Hyderabad
in a stabilisation of rental and capital values in Pune & Chennai
most of the markets. The period from 2Q10 to 3Q11F Mumbai
& NCR Delhi
Bangalore
2Q10
3Q11 provides a strategic window of opportunity
for both buying and leasing CRE, when both rental STRATEGIC WINDOW OF
OPPORTUNITY
and capital values are at their cyclical low. Capital
values typically are a leading indicator and signs of
Source: Real Estate Intelligence Service (JLL), 2Q10
strengthening of capital values in selected micro-
markets have already been witnessed. Post 2011,
moderate growth of capital values is forecasted
for office markets in India. Mumbai and NCR-Delhi
office markets are expected to lead the property
clock followed by Bangalore and Chennai.

Read our research publication – The Slope of Descent released in March 2009

The slope of In the whitepaper, we had forecasted that the fast moving office markets (mainly prime markets), which are relatively less
descent affected by conditions of oversupply, would start recovering in 3Q10. Six quarters hence, when we analysed the conditions
during 2Q10, the forecast for these markets remains in place. Property values in these prime office markets such as
CBD and BKC of Mumbai, CBD of Delhi and MG Road of Gurgaon have already started recovering. The aggressors and
followers (mostly SBDs and suburban markets), which have considerable amount of supply in pipeline, would remain stable
A closer look into India’s rental dynamics

for a longer time and should recover only in 2H11.

 Advance - Corporate Real Estate and the Decision to Lease or Buy 15

Authors
Himadri Mayank, Manager, Research & REIS
himadri.mayank@ap.jll.com
+91 22 6141 6513

Himadri Mayank joined Jones Lang LaSalle India in July 2008 and is responsible for managing the
quarterly research offering – Real Estate Intelligence Service (REIS), which tracks, analyses and
forecasts trends in office, retail and residential property sectors for Indian cities. Based out of Mumbai,
he also contributes towards regional and local research publications covering economy, sector analyses,
market forecasts and investment strategies.
He holds a degree of B.Arch. from Indian Institute of Technology Kharagpur and has three years of
experience in the field of real estate. He is pursuing the Chartered Financial Analyst (CFA) program
offered by CFA Institute, Charlottesville and is a 2011 Level III CFA candidate.

Avinash Mirchandani, Associate Director, Research and REIS

avinash.mirchandani@ap.jll.com
+91 22 6141 6500

Avinash Mirchandani supports the Jones Lang LaSalle India Research & REIS team. Based in Mumbai,
he provides guidance and oversight on all of the team’s research outputs and bespoke client projects.
Avinash originally joined Jones Lang LaSalle in 2007 as the programme manager for the World Winning
Cities Research Programme, a multi-year research initiative conducted by our Global Research team.
Prior to that, he worked in a variety of consulting and research roles across the biotech, aerospace and
IT industries in the United States. Avinash holds a bachelor’s degree in Economics from UCLA and an
MBA from the Indian School of Business.

Abhishek Kiran Gupta, Head of Research & REIS

abhishekkiran.gupta@ap.jll.com
+91 22 6141 6500

Abhishek Kiran Gupta leads the Jones Lang LaSalle India Research team and is based in Mumbai.
He manages research operations on a Pan-India level and is responsible for the team’s outputs,
including research reports such as topical white papers, property market digests and bespoke research
projects based on specific client requirements. Prior to joining Jones Lang LaSalle, he had seven
years of experience in market research, business analysis and market strategy consulting, servicing
diversified industries including pharmaceutical, software publishing and insurance.

Acknowledgements
Ankit Bansal from Jones Lang LaSalle’s Research has also contributed to this project.
About Jones Lang LaSalle
Jones Lang LaSalle (NYSE:JLL) is a financial and professional services firm specializing in real estate. The firm offers integrated services delivered by
expert teams worldwide to clients seeking increased value by owning, occupying or investing in real estate. With 2009 global revenue of USD 2.5 billion,
Jones Lang LaSalle serves clients in 60 countries from 750 locations worldwide, including 180 corporate offices. The firm is an industry leader in property
and corporate facility management services, with a portfolio of approximately 1.6 billion square feet worldwide. LaSalle Investment Management, the
company’s investment management business, is one of the world’s largest and most diverse in real estate with approximately USD 40 billion of assets under
management. For further information, please visit our website,
www.joneslanglasalle.com.
Jones Lang LaSalle has over 50 years of experience in Asia Pacific, with over 17,800 employees operating in 76 offices in 13 countries across the region.

About Jones Lang LaSalle India

Jones Lang LaSalle is India’s premiere and largest professional services firm specializing in real estate. With an extensive geographic footprint across
ten cities (Delhi, Mumbai, Bangalore, Pune, Chennai, Hyderabad, Kolkata, Kochi, Chandigarh and Coimbatore) and a staff strength of over 3500, the firm
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Real Estate Intelligence Service (REIS) India is a subscription based research service designed to provide you with cutting
edge insights into India’s diverse and challenging real estate markets through collation, analysis and forecasts of property market
indicators and trends across all major Indian markets across various real estate asset classes - office, retail, residential.

REIS empowers you with consistent and complete market data and analyses for all real estate indicators by specific micro markets.
It is supplemented by value added services including client briefings, presentations and rapid market updates.

For more details, contact, Abhishek Kiran Gupta - abhishekkiran.gupta@ap.jll.com

or Avinash Mirchandani - avinash.mirchandani@ap.jll.com

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