Can services sector revive the office property mart?

Recently, the annual GDP number (6.5 per cent GDP growth during fiscal year April 2011-March 2012) released by the Reserve Bank of India (RBI) resulted in a negative sentiment throughout the real estate industry.

Consistent with this, in 1H12, the demand for commercial real estate moderated on the back of office occupiers that remained cautious about their expansion plans.

However, the economy’s services sector has continued to experience strong growth and is advancing at a rate of 8.5 per cent in FY’12. This indicates that a major slowdown in office real estate demand is not likely to occur - the services sector generates the highest demand for office space in the country.

Over the years, the services sector has been the growth engine of the Indian economy. Its growth rate has outperformed the overall growth rate of the country’s GDP, which also includes the agricultural and industrial sectors, all comprising the three major sectors of the economy.

The services sector is comprised of the following industries:
*Banking, financial services and insurance (BFSI)
*Information technology
*Consulting
*Trade, and
*Communication

These are the major drivers of demand for commercial real estate in the country. The services sector has also been one of the country’s core sectors over the past decade, as its contribution to GDP has significantly increased from 50 per cent in FY96 to 63 per cent in FY12. In FY12, when all other sectors (including agriculture and industry) performed very poorly at an average of 3.1 per cent, the services sector recorded a healthy growth rate of 8.5 per cent.

Overall GDP and Services Sector Growth of India

Source: Reserve Bank of India

(Note: Overall GDP growth is the average growth of all sectors of the economy including services sector as a component) FY06 indicates financial year that starts on April 2005 and ends on March 2006.

It is estimated that in 2011, the service sector accounted for about 70 per cent of the demand for commercial office space in the seven major Indian cities of Mumbai, NCR-Delhi, Bangalore, Chennai, Hyderabad, Pune and Kolkata, with the remaining 30 per cent coming from manufacturing and other industries. In the services sector, the IT/ITeS and BFSI industries contributed the most at 35 per cent and 16 per cent respectively.

Over the years, consulting services have shown strong office space demand, which has grown from nearly 3.8 per cent of the total demand in 2009 to 13 per cent in 2011. Therefore, the growth of commercial real estate demand depends principally on the growth of the services sector.

The slowdown in GDP growth in FY12 can mainly be attributed to high interest rates, inflation and a significant contraction in industrial production. However, the growth in the services industry, at 8.5 per cent, has been robust enough to support overall GDP and the sector itself. The IT/ITeS sector, which is one of the major constituents of the services industry, recorded a growth rate of 13 per cent in FY12 and is expected to grow at a similar rate during the next financial year.

Additionally, the BFSI industries registered a robust growth rate of 10 per cent in FY12. Although the manufacturing and industrial sector is performing poorly now, the continued health of the services sector is likely to compensate for it by contributing a larger share.

The Reserve Bank of India projected that the Indian economy would grow at 6.5 per cent in FY13. As compared to many major world economies, this growth rate is fairly healthy; in addition, an established services sector should help India resist any slowdown in office real estate demand.

(The author is Senior Manager of Research with Jones Lang LaSalle India)