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The Great Indian Warehousing Sale

Yesh Ravel

Executive Director, Fund Management & Corporate Strategy, Welspun One

25 September, 2020

Shoddy, poorly kept and managed godowns are giving way to modern, tech enabled and professionally managed logistics parks.

“Smart money” has already picked up on this trend and is aggressively chasing this asset class. Could this be the next big investment opportunity for domestic capital?

The warehousing sector in India is at an inflection point, with demand estimated to grow at a compounded annual growth rate or CAGR of 20-25% over the next 4-5 years. 2019 witnessed significant activity with 36 million square feet of absorption, just a shade below office absorption for the year at 42 million square feet.

There are a couple of factors at play here ranging from a favourable macro environment, government policy push and the rapid acceleration of e-commerce over traditional retail, especially in the current context- the ongoing COVID-19 pandemic in addition to a migration of occupiers from non-compliant, poor quality “Grade B” stock to compliant, high quality, modern “Grade A” stock.

It is particularly interesting to note that India is significantly undersupplied, in terms of warehousing stock per capita compared to regional and global peers. We are currently at about 0.1 square feet per capita, China is 80x of that at 8 square feet per capita and the US is at about 400x of that at 40 square feet per capita. As income levels and consumption patterns undergo a change, India clearly has a lot of headroom for growth.

E-commerce is emerging as a key contributor to growth, especially in Tier 2 cities which are expected to constitute a meaningful portion of future growth.

It is also helpful that there has been a deliberate policy push by the government to develop the sector in the form of a National Logistics Policy which aims at reducing the cost of logistics from about 14% of GDP to 10% via several initiatives including particularly the development of a strong warehousing and cold chain sector. Other initiatives like the Goods and Services Act, have been a game changer by removing the need to have small de-centralised warehouses to optimize taxes, instead moving towards larger consolidated facilities. This has translated in to an approx. 4x increase in the amount of institutional capital invested in the sector post GST (versus pre-GST levels).

“Smart money” had already been chasing warehousing; post-COVID-19, the sector looks even more attractive

Even pre-COVID-19, “smart money” from large institutional investors had begun flowing into the warehousing assets globally as well as in India. Over the past 2-3 years, institutional investors have committed over $5 billion to the Indian warehousing real estate sector. The reason warehousing makes for an interesting investment proposition is the fact that along with favourable long term demand-supply dynamics, it is one of the few asset classes which provides both attractive development returns and stable long term rental yields.

Post-COVID-19, warehousing has gained even more attraction as it has shown itself to be relatively resilient to shocks in the short term. While offices, malls and hotels struggle with low occupancy, warehouses are still buzzing with activity with most e-commerce players aggressively looking to ramp up their warehousing footprints to keep up with increasing demand. In the mid-long term, warehousing demand may accelerate further owing to widespread increase in inventory levels across industries as well as in anticipation of supply disruptions.

A safer alternative to traditional rent yielding assets and a potential “arbitrage” opportunity

Warehousing offers two potential investments theses of which could be of interest to domestic investors. Firstly, it serves as a substitute or a diversification from traditional rent yielding commercial office asset classes, given an uncertain outlook for office demand.

Second and perhaps more interesting is the potential “arbitrage” on participating in green field development where investors can enjoy a disproportionately higher return for relatively lower incremental risk. This is due to the fact that warehousing is relatively de-risked from an approval and construction risk perspective given a shorter development cycle (usually 9-12 months ground up) and lower construction complexity relative to other segments of real estate like residential, office, retail, hospitality, etc.

Leasing risk can be mitigated by “pre-committing” a tenant or by way of a “built-to-suit” development. Leases are also usually very long term (5-10+ years) and are extremely “sticky” given that tenants often end up spending as much if not more than the development cost of the asset on fitting out these warehouses, making it very hard for them to vacate a space in favour of a competitor, even if offered a lower rent.

As investors grapple with rebalancing their portfolios to manage risk in a post-COVID-19 world, warehousing could be one of the few bright spots in an otherwise difficult investment landscape.