CRE Edge: Wealth generation through investments in CRE | Our CEO in conversation with Moneycontrol

Focus ideator innovator enable money control and property share present CRED India's commercial real estate has been the blue-eyed boy for global private equity funds and HNIs since it offers investors a wide range of investment options such as office buildings, retail spaces, warehouses, and industrial properties. Commercial real estate investments have been known to generate a steady income through rent and appreciation in property values over time. These investments can also provide diversification benefits to an investor's portfolio as the performance of commercial real estate market may not be closely correlated with other asset classes such as stocks and bonds.

Hello and welcome to Money Control and Property Share present CRED Edge: Wealth Generation through Commercial Real Estate. We have with us Kunal Moktan, who's the co-founder and CEO at Property Share. He is an MBA from IIM Ahmedabad and has 13 plus years of experience buying, managing, and selling real estate across the globe, of which eight years he was with the Blackstone Group, the world's largest real estate fund with AUM of more than $150 billion. Kunal, thank you so much for joining us here on this show where we are going to be talking all about commercial real estate and what the outlook of this particular asset class is as well. So let's start with the first question. Of course, because we've seen this big growth in real estate, the last two years have definitely seen that churn in the real estate cycle as well. How do you see this cycle changing or what is the outlook here, and specifically for commercial real estate as well?

Firstly, thank you so much for having me here. Happy to be here in your studios. And yes, I mean, real estate has grown in a big way over the last few years, over the last 20 years actually. In India it's changed quite a bit, and the last few years have been very, I would say, quite unstable with COVID coming in and people asking questions about commercial real estate because people are not really going to offices. So people questioned the very nature of going to work, whether people lease offices, buy offices, and so on. But you know, dynamics of real estate are quite different and we need to kind of understand that there are different factors at play in India. For example, to answer your question, real estate has grown in a big way. Last year in 2022, we had the most leasing in the last 10 years, 40 plus million square feet, which is amazing. And of course, some of it was pent-up demand from COVID, from the fact that there was no supply, builders couldn't build anymore because there were restrictions on construction and so on. But a lot of it also has to do with the fact that India continues to be one of the strongest countries in the world in terms of workforce, in terms of costs. And for all these multinationals who are the key drivers of real estate in India, the Apples, Microsofts of the world, India is the one place they can go to set up centers at lower costs and where they have access to a very large talent pool. So I'm assuming that that's something that's going to keep driving demand for real estate going forward, although I do believe that it's going to temper a little bit over the next year or so. This year is, I would say, very, very key to what's going to happen in commercial real estate.

So that's exactly what my next question is going to be, because we've been hearing these big talks around recession. IMF, World Bank, all of them have indicated that yes, it possibly could be a EUR recession. In that case, how does India stand out? That is something that you were explaining as well, and what is the outlook in that case? If you can explain it a little bit more to us.

I think that the world has already entered recession if you ask me. If you look at the definition of recession, that's already been satisfied in most of the western world, whether it's the UK, the US, or Europe. And India, of course, is always lagging behind a little bit in terms of supply and demand catching up, but I think we're getting there. And I would think that we are in the middle of a recession. The key difference this year in terms of commercial real estate versus, let's say, 2008-09, the cycle that I saw when I was in Blackstone and then the big boom after that, is that at that time it was a financial services crisis. But a lot of these banks were still outsourcing to India. Morgan Stanley opened its largest outsourcing center in Pune and Bangalore and Hyderabad. Apple, Amazon, all of these guys were coming to India. But this year, it's been a little different. If you read the news, Morgan Stanley has been firing, Goldman Sachs has been firing people in India, not just in the west. And that's something that's a bit concerning for me. I feel that those were the key institutions who were driving demand for commercial real estate in India, and if that slows down, then demand for real estate will certainly slow down in the country. And then the other big bit which was driving real estate demand was startups, less sees in India. They were kind of signing lots of big leases, PMS of the world. But over the last one year, as we know, funding has completely dried up in the technology space and there's been a lot of firing all the way up top from like BYJU's, a 20-30 billion company, to a series B funded startup. So none of these guys are looking for space, they're working from home. I think that this year is going to be very difficult. But like I said, Indian dynamics are very, very different and I do believe that it'll not be a very steep fall, but we are definitely past the stage where we see 40-50 million square feet being added every year in India.

Okay, so 2023 could slow down, but of course the long-term idea of the commercial real estate segment is strong. So in that case, from an investor's perspective, real estate of course traditionally has been the go-to place for Indians for investments in property, but they talk about residential real estate. Commercial has still not picked up so much despite REITs coming in, despite a lot of action taken here as well. How should an investor look at commercial real estate when it comes to building their portfolio? How important is it?

It's very important. And Indians love real estate, as you know. When I got my first bonus, I invested it in a flat. I'm sure anybody else, everybody else in this room did. That's the first thing we buy when we get some money. So Indians have always, Indian business communities have always invested in real estate. Commercial real estate, Nariman Point, if I give the example since we are in Bombay, is almost entirely strata owned, which means that it's completely owned by different individuals, different floors. Only one or two buildings in Nariman Point are owned by one institution, one of which is the Blackstone building, Express Towers. But there was a time when Merrill Lynch was a tenant in Nariman Point and they used to write 30-40 plus checks every month because there were 40 landlords. They had all come together and bought a floor because even then people recognized the fact that commercial real estate is something that's a very good asset class to invest in. And the main reason for that is it's a hybrid instrument between a debt instrument and an equity instrument. So you get 8-9% rental yields, which you know because the tenant is in place, you know how much rent he's paying. If you buy it for 100, you know you're getting 8 or 9 rupees every year. On top of that, there is this capital appreciation, so you could also get growth on your underlying real estate, which is typically 5 to 10% a year. So basically you end up making 13 to 18% unleveraged IRRs in commercial real estate as long as supply and demand stay in check. And that's something that people have found to be very appealing as an asset class to invest in. And thirdly, every lease in India is indexed to inflation. If inflation is 5%, then what you're earning from your instrument gives you the same basket of goods that you would have got a year before. So if at 8 rupees you got like 8 cages of rice and rice goes up by 5%, then you still get 8 cages of rice next year because it's an inflation-linked product. That's amazing. And so basically the yield plus the equity portion of the instrument is something that's really been appealing for Indian and global investors. That's the reason why Blackstone, KKR, Brookfield, they all came to India because they saw this massive opportunity to buy assets at such high yields and make such high unleveraged returns.

Yes, of course. That's the reason we're seeing this era of REITs coming to the market as well. So can you give us some sense to our viewers as well, what are some investment avenues here if they want to invest in commercial real estate? What would the pros and cons be, something that these people should be aware of before investing?

So before REITs, there were really no avenues for foreign investors to invest, which is pretty sad. All around the world, REITs give you access to rent-yielding real estate, but in India we didn't have that. And in my previous job, of course, I did a lot of lobbying and we got the REIT regulations in place because we had created a portfolio which was so big that it could only be exited through a REIT. But after REITs, now the few options for investors today are: you go through the REIT to buy a basket of securities. Now the yields on REITs are not great unfortunately, because they have a portion of their portfolio which they have to invest in under construction or land. Therefore, even if the yield on the 80% is 8, on the 20% is zero, so you end up making 6-6.5% yield and you are exposed to market fluctuations. If you see the price of Embassy REIT today, it's the exact same price that they listed at four years ago, it's 304 rupees. And a person who bought in at 450 rupees is obviously losing 50% of his capital. So that's one avenue to invest. The second avenue is just buying real estate yourself. Now that is not recommended at all, especially in commercial real estate, because if you only have, let's say, 50 lakhs or 1-2 crores to invest, then all you can buy is a small quarter of a floor in a building where the tenant will not be a blue-chip multinational, it will be a law firm or a CA firm. And during COVID, those are the first ones who will not pay you rent. If you want access to blue-chip multinational tenants, grade A plus buildings, then you need 100 crores plus. And therefore, that option no longer exists, and people who bought one or two crores worth of assets really burnt a lot of their money. The third option is what we provide, which is a platform to buy these 100 crore assets with a blue-chip tenant, grade A plus buildings of your choice at 8 to 10% yields, at 25 lakhs minimum. So that's something that is a technology-driven investing opportunity that's available today, which has become possible thanks to just the way technology has grown over the last 6, 7, 8 years. We are buying everything online, why not real estate online?

We spoke about what are the pros and cons and what are the investment avenues as well. Can you tell us what are the key parameters one should be looking at while they are thinking of investing in commercial real estate, because that's not the traditional way to go about as well? So what should an investor be watching out for?

It's a very interesting question and something that people take very lightly. But when it comes to commercial real estate in particular, there are a few things that are really very, very important. One thing, of course, is location. For any real estate asset, you need to be absolutely sure on which location you're buying. When you're buying commercial real estate, you want to buy it in a location where there is a lot of demand, where there's very little supply, and rents have been going up steadily. You should also look at what's the replacement cost of the asset. That's a very technical term, but basically what it means is: if instead of buying this asset, I break it down, buy the land, build the whole asset, lease it, is the price that I'm paying a discount or a premium to that? And you should always be at a discount to replacement cost, because if you are not, then people will just keep building more. That's an important thing. The third thing you should see is your rental yield versus the market rental yield. So if you are paying 150 rupees a square foot here but the market rent is 125, and I buy this building at 8% yield, I'm very happy to buy it, but I know that tomorrow when your lease comes up for renewal, you have like 10 other buildings to go to at 125. So the market yield is much lower than what you are buying at, and that's a mistake that a lot of amateur investors make. And that's something that institutions look at a lot more closely than normal retail investors. That's also something that you should look for. And of course, the two or three big hygiene things: who the developer is, is he a great A+ guy, is he going to build as per specifications, the quality of the building, how has he built it, and just who the tenant is. That's critical. If you buy with a tenant who's, let's say, a B-grade tenant, then the chances are very high that he's going to leave this building or he's not going to take care of the building, or you're not going to have someone if something like COVID or something hits. When COVID hit, every one of the big multinationals stayed in their leases, almost all of them. So that's something that's very helpful when you are buying commercial real estate.

So how in that scenario does Property Share help the investors? Can you tell us more about this and what are the key parameters that you look at as well?

So like I said, I come from a very institutional background of investing for Blackstone for 7-8 years, not just in India but also around the world. And during that time, I got real exposure on how institutional investors invest in real estate. And that's exactly the same thing that we try to replicate in Property Share today. If you go and look at a Property Share listing on our website, you will not see anything different from the way we used to present to the investment committee in New York in Blackstone. You will have the same kind of rigorous analysis, the financial modeling, the sensitivity analysis, the layouts, the photographs, the videos, why you should invest in this asset. And the aim is to give a normal investor institutional analysis so that he knows and he's prepared for what he's getting into. So that's something that we really focus on, and I think that really helps users on the platform invest in commercial real estate.

That's very interesting and that's a differentiator as well, right? Can you talk more about it and how are you using technology to leverage that market positioning that you have as well?

So if I talk a little bit in more detail on the underwriting, on how we underwrite deals, one is, of course, the legal due diligence, which is super, super important. We use a tier-one law firm, one of the top four law firms which actually even the likes of Brookfield or Blackstone use in India, to make sure that the title is clear, to make sure that the approvals are in place. We use a very high quality technical diligence to make sure that the building is high quality, that all the lifts are functioning properly, that the DGs are working, they have enough life left in them, the lobbies are well done, the floors are very well designed, the core is in the middle, all of those technical aspects. And then we also do a very detailed financial diligence to make sure that there's nothing outstanding on the property, encumbrances like debt and so on. And we pass all of that to the normal user. That's something that I think has really set us apart over the last few years. On the technology bit, we are a tech platform. Ultimately, all our investors invest online. They just go, they open their tablets or phones, they could be anywhere in the world, they could just open our website, they could look at the entire underwriting, the photos, the video, they can click on invest and go through the entire process within a matter of seconds and become an investor in the property. The transfers, the rent distributions, everything happens online. And that's something that's really changed over the last 6-7 years. And we were one of the first people to start it, not just in India actually, around in the world. And we've been at the forefront of it. We manage the most amount of assets in the country. And we use technology from very simple things like underwriting. If I were to give you an example, the way a normal fund would do underwriting is obviously you'd go and see the asset, you'd kind of do the modeling and so on. What you can do with technology is now you have data for thousands of properties. I know how these properties have done in the last 10-15 years, I know which properties made money, which did not. So we created a very interesting artificial intelligence tool which learns by itself about a location, about a property, about a tenant. You feed it millions of data points and it can tell you that in Powai, if you buy a building where the rent is 150 or more and the tenant is a multinational, you're going to make 15%. But if you buy it in BKC, the price is so high that you'll have to sell at 50,000 rupees a square foot in three years, people have not made money there. So if you feed the data into this model, it spits out a buy, negotiate, or exit decision straight away. So the technology is ultimately going to replace me as the investment manager, and that's the whole point. I don't want to be the guy going from city to city and looking at properties when technology can do it. You can just draw data from all the sources we have today and tell you, 'Look boss, this is a great asset, you should just buy it.'

That's scary and exciting as well, right? So okay, so while we are talking about what the platform does and you have spoken about your years of experience in the commercial real estate, what are some of the challenges that you faced when it comes to investing? Because I'm sure it's not all rosy, right? So can you share some of that with us?

The challenges in investing in real estate in India: the first biggest challenge is that there's hardly any supply to buy. If you want really good quality assets at great prices, there's just not enough assets to buy in India. And that's the challenge that every fund manager has faced in India. And it comes in bulk. Sometimes you have nothing for six or seven months, and sometimes you get the prestige opportunity for one and a half billion dollars where you can deploy a lot of your fund. That's one of the big challenges of investing in real estate. And the second big challenge is just the quality of data that's available in India versus around the world. When we used to look at the teams in New York or London or Tokyo doing deals, they had such tons of data to base their decisions on: supply, demand, who's been leasing. India, there's no real database. Only now there are a couple of databases which have come up, but it's very difficult to know if I want to know every building in BKC and what the last 10 years' lease rates have been or who has bought and sold there, it's just not available. And then there's this whole question of whether the real price of the asset was paid or not when the purchase was made. So you are a little bit in the dark when you are kind of doing deals in India, which I think is a little bit of a disadvantage of doing deals here.

Yeah, hope someone's listening to that and plugging that gap. There are a few guys who are doing some good work there. Okay, that is good to know. So, last question before we end this interesting conversation. At the end of the day, everyone looks at the returns or the investment which has come out giving fruitful returns to investors. Can you share one of these investments with us? What was it like, what kind of returns did you see, and what was the entire experience there?

Sure. We've exited one property on the platform. In India, if you sell before 3 years, you have to pay a really punitive capital gains tax, so you typically wait for at least 3-4 years before you sell real estate in India. We sold one in the middle of COVID. It was an office building on Outer Ring Road in Bangalore. It satisfied all the parameters that we just spoke about: great location, great tenant, great building, vacancy levels were really low, market rent was lower, replacement cost was really high, and so on. And we bought it at 8,800 rupees a square foot and ultimately sold it at an 18% IRR to a single investor. So I think that's one of the most profitable exits that we've made, the only exit we've made so far. I think next year we're going to make a few more exits which are going to be similar in nature. But yeah, like I said, those are the typical returns that one would hope to make in real estate.

Okay, so your investors definitely are happy there. I hope so. Okay, so one follow-up on that actually, because we saw a lot of changes coming in as far as the taxation bit on the budget is concerned, that's for REITs generally. But do you think more changes need to be made? You spoke about pushing for REITs at least to make this very regulated market. Anything else that the regulator can do, because you have seen this market over years? What is something that can make this segment or this asset more attractive?

SEBI, I think, has done a very good job as a regulator in India, I have to say. They've been conservative and they've kind of come up with the right regulations at the right time. REIT was a great regulation for Indian investors to participate in, which is great. But yes, there's definitely more things that they can do, and there's something that we are working with them as well. In the west, if we see, that's the more developed market, they are years ahead of us in terms of real estate regulation. And there you have stuff like one-asset REIT or mini REIT. You don't have to have such challenging regulations where the REIT has to have 500 crores of asset, 250 crore public float. You could even have a 100 crore REIT, which will help a lot of people who have smaller office buildings also come up and liquidate in the market and get retail investors. I think in that area we're still a little bit lagging. We have a lot of people who want to invest in real estate and who are not investing in real estate and going to other avenues which are not really optimal in terms of returns. So I think that's something that I hope the regulator will do.

Okay, so that is something that you expect from the regulator. But it was definitely a masterclass in commercial real estate and what Property Share is doing as well. Kunal, thank you so much for those valuable insights. And with that, we'll come to the end of this show. Thank you so much for joining us, and stay tuned for more updates. Money Control and Property Share present CRED.

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