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    Review of Indian Retail Real Esate 2013 & Outlook for 2014

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    The GDP growth for the financial year 2012-13 stood at 5.0 percent year-on-year as against 8.0 percent average growth over the last five years until FY2011-12. The first quarter of FY2013-14 provided no respite – growth fell further to 4.4 percent year-on-year.

    The services sector, which is the primary driver of demand for grade A retail space in India, has witnessed a consistent slowdown and is yet to show concrete signs of revival. Growth of the FIRE sector (Financial, Insurance, Real Estate & Services), which stood in double-digits over the last five years, came down to 8.5 percent during the previous financial year and currently remains at that level.

    Growth in consumption spending, which stood on at an average of over 8.0 percent during the five-year period until FY2011-12, fell sharply to 3.9 percent year-on-year as of the last financial year (FY2013) and 1.6 percent during Q1-FY14. Further, steep rises in the price of food items (vegetables and fruits) necessitated increased expenditure on basic and essential goods.

    The growth of the retail sector stood at 9.7 percent year-on-year on an average during the five years until FY2011-12. Last year (FY2013), it fell to 6.4 percent year-on-year. Q1-FY14 performance was even worse, recording growth of a mere 3.9 percent year-on-year.

    For the 10 prominent national retailers listed on the Bombay Stock Exchange, quarterly net profits for the first two quarters (ending June ‘13 and September ‘13) of the current financial year reflected weakness. In addition to the economic slowdown, AT Kearney’s GRDI report for 2013 also highlighted the difficulty that Indian retailers had to face during the last few quarters. The report stated: “High operating costs, low bargaining power with vendors, and heavy discounting to improve sales have affected profits and expansion plans. Real estate cost and space availability also remain important issues.”

    However, a few retailers did exhibit marginal growth even in these difficult times – including Shoppers Stop, Trent Retail, and Indian Terrain as they benefited from the premium brand positioning. The trend is further reflected in the performance of international retailers who have recently forayed into India. Brands such as Zara, Marks & Spencers, Benetton and posted a healthy jump in their year-on-year revenues. The international players have bucked the general trend by offering stylish designs at prices that were reasonable to Indian consumers. The above four global brands collectively achieved sales that equalled the apparel sales of established department store chains such as Shoppers Stop and Lifestyle International.

    After several years of clamour and hesitation, the Indian Government fully opened up FDI investment in single-brand retailing towards mid-2012. Large single-brand retailers such as , Christian Louboutin, Starbucks, Dunkin Donuts, and Armani Junior, entered the country. IKEA, a large furniture chain, is also finalising its India entry strategies, with plans to invest around Rs 10,500 crore.

    Later during the same year, the Government also raised the FDI limit in the ‘politically contentious’ multi-brand retailing segment from nil to 51 percent, albeit with certain pre-conditions. While many had believed that this move would incite international players such as Wal-Mart and Carrefour to accelerate their entries into the Indian market, none of those retailers have submitted their investment plans yet.

    After analysing the FDI pre-conditions, global retailers voiced their concerns over some of them which they perceived as excessively rigid, i.e., minimum USD 100 million investment, maximum 51 percent stake by foreign retailer,  5-year window to achieve 30 percent sourcing from SME sector, and 50 percent of the FDI investment to be channelled into creating back-end infrastructure. The first two conditions cumulatively require the joint venturing partners to invest more than Rs 1,000 crore. Since food and apparel is the highest-selling segment, retailers would be inclined towards investing in it despite the high competition in the segment. Other retail segments may be too small to accommodate such magnitude of investment.

    Realising that these pre-conditions created genuine difficulties in execution, the Indian Government announced measures to relax these norms in August 2013. Therefore, on the policy front, 2013 was a year of realisation and negotiation with foreign retailers.

    In an otherwise somnolent market scenario, Chennai’s performance was notable. The city witnessed the strongest retail space absorption during the first three quarters. As a consequence, vacancy dropped by ~6.0 percent. Paradoxically, overall rentals and capital values in Chennai slipped the most, largely owing to large influx of supply in the suburban locations where prices are cheaper.

    Kolkata and Mumbai came in as the second and third-best performing markets, recording relatively strong absorption figures. Unlike in Chennai, the increased demand in the two markets was not supported by strong supply. As a result, overall rentals and capital values increased in the range of 5-10 percent year-on-year.

    Among other Tier-I cities, Delhi-NCR and Bangalore witnessed poor absorption. With marginal absorption and an increase in stock supply, Pune retail real estate witnessed marginal fall in rental and capital values.

    Currently, organised retailing accounts for only around 7 percent of India’s total retail market size, while the remaining is constituted of the unorganised sector. When comparing this ratio with other emerging nations such as Brazil (35 percent), Russia (30 percent) and China (20-25 percent), organised retailing in India clearly appears under-penetrated. In most of the developed markets, organised retail accounts for anywhere between 66 percent (in Japan) and 85 percent (in the US).

    The fact that India, along with China, presents one of the best population characteristics in terms of spending potential makes it an attractive market for global retailers. Increased urbanisation in the tier-II and III cities, along with a steep rise in rural income levels, presents a big opportunity for retailers, coupled with the benefit of low real estate costs in the cities compared to the expensive tier-I cities.

    Year 2013 has once again highlighted that retailers cannot afford to ignore India. Nevertheless, obstacles to faster growth – such as unaffordable real estate rates, complex taxation and FDI policies, intense price competition from the unorganised sector and on-going economic slackness – continue to be challenges.

    Macroeconomic fundamentals are unlikely to change during the first half of year 2014. In the second half, sentiments will be driven by election results, the state of inflation and global growth outlook. On the domestic front, high inflation, exchange rate volatility and high current account deficit have been acting as a drag. Considering good monsoons production which will hit the markets soon, inflation will gradually subside beginning 2014. However, there are external factors at play as far as capital flows (essential to fund deficit in the current account) and rupee volatility are concerned. These risk factors could deter investments from foreign multinationals.

    However, international retailers realise that the best time to enter India is when real estate prices (one of the major concerns for retailers) are stable. The potential resolution of various policy issues and the sustained attractiveness of India’s consuming class (favourable demography and rising incomes) will help boost the interest of global retailers in 2014. Nevertheless, uncertainty remains with regard to general elections and the subsequent fate of large investments by retailers. As of 2014, India’s retail sector has the potential to reach around Rs 25 trillion. The size of the retail market is around Rs 19.2 trillion (as of 2012), accounting for 22 percent of India’s GDP.

    Close to 900,000 square meters of additional retail space supply is going to hit the pipeline in 2014, as against the 590,000 square meters in 2013. Cities such as Delhi, Hyderabad and Bangalore will witness good supply of retail space, largely around the expanding city peripheries. However, rental and capital values will remain stable in most cities on account of the on-going slowdown in the real estate sector. Viewed cumulatively, these factors will prove to be incentives for retailers to enter the market or expand their business.

    As a retail category, the F&B segment accounts for the highest share (~70 percent) of the total retail market size. However, the organised sector’s share in this category – a high-volume / low-margin segment – currently stands at only 2-3 percent.

    On the other hand, ORP in the relatively high-margin categories such as clothing (~20 percent), footwear (~17 percent) and beauty & personal care (25-30 percent) will be higher in 2014, as modern retailers are looking to increase their foothold in the abovesaid segments given the rising lifestyle aspirations of Indian consumers. The increased foothold of the organised sector will create demand for additional mall space.

    Year 2014 may not be significant in terms of foreign direct investments into the retail sector. In the normal course, once the investment proposals are approved at the Centre and State levels, a new entrant large-scale retailer require around 18 months to procure the requisite mall space, create backend infrastructure and set up procurement contracts. Also, for the partnering Indian retailer, existing operations will have to be restructured in order to meet the FDI policy conditions.

    Despite the relaxation of certain criteria in the FDI policy in August 2013, foreign retailers are unlikely to enter the hypermarket business in India before the 2014 elections because while it is mandatory for international retailers to be in joint venture with Indian retailers, finding a suitable Indian partner is difficult.

    About the Author:

    Anuj Puri is the Chairman & Country Head of India.