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2006

World Winning Cities Series Emerging City Winners

INDIA A Real Estate

Investment Future India’s real estate investment market is rapidly growing and following the relaxation of FDI regulations the country is attracting substantial interest from cross-border real estate investors

INDIA Emerging City Winners

Cross-border real estate

investment in India The rapid growth of India’s Business Process Outsourcing (BPO) activities and its impact on a burgeoning commercial real estate market has been well documented. Less attention has, so far, focused on the emerging opportunities for cross-border real estate investors

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ndia’s real estate investment market has grown rapidly over the past 18 months, and following the partial relaxation of FDI regulations in February 2005, the country is now attracting substantial interest from cross-border real estate investors. This report reviews the case for real estate investment in India, and assesses the current and potential future opportunities and constraints in this rapidly evolving market. We identify the key growth sectors, and as part of Jones Lang LaSalle’s World Winning Cities programme we highlight the real estate investment potential of India’s growing number of "emerging city winners".

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The report concludes that: The Indian real estate market offers cross-border investors with an attractive investment opportunity underpinned by a booming and increasingly diversified economy, significant potential for rapid expansion in FDI and a maturing real estate market. It will be those investors who have a long term strategic vision and commitment to India that are likely to be the most successful. India is reaping the benefits of 15 years of reforms, and its economy is now set for a period of strong and sustainable growth. By 2010 India will be the world’s third largest economy (measured in purchasing power) and is expected to have a middle class of around 300 million people, larger than the USA. India has a large skilled labour pool, with 2.5 million new graduates added to this pool each year, most of whom are proficient English speakers with strong technical and quantitative skills.

Whilst the Indian real estate market still lacks transparency and liquidity compared to more mature real estate markets, its market structure is changing fast in response to the demands of multi-national occupiers. Jones Lang LaSalle’s latest Global Real Estate Transparency Index (2006) shows that India has achieved one of the region’s most significant improvements in real estate transparency over the past three years. Moreover, the increasing participation of cross-border investors and the emergence of new investment vehicles (including the likely introduction of REITs as early as 2008) will continue to force the pace of structural change over the remainder of the decade. A significant weight of domestic and global capital is now chasing Indian real estate, but activity is currently being constrained by limited availability of high quality product. Singapore developers and US opportunity funds, which have dominated the cross-border market so far, are focusing on IT parks and

residential schemes. They are now being joined by other Asian and European investors, who are currently exploring opportunities. The market will see more investment by domestic and cross border real estate funds.

ownership and title issues, short leases and some concerns over long term asset price inflation, added to which are the broader risks of an economy vulnerable to economic shocks, infrastructure strain and environmental stress.

Suburban offices and the residential sector are likely to offer the greatest opportunities over the short term, and over the medium term opportunities in the retail sector will grow:

Nonetheless, India is a vast and diverse country, and risks can be reduced by careful location selection:

Suburban Offices Occupier demand will be supported by a 30%+ annual growth forecast for the IT/ITES sectors. Strong growth in emerging sectors such as telecoms, financial services, pharmaceuticals and biotechnology will also boost demand and broaden the occupier base. State-of-the-art campus developments are expanding rapidly, and sale & leaseback opportunities are emerging. Residential Favourable demographics, urbanisation, rising incomes and easier access to finance are fuelling strong demand for residential accommodation. India has an acute shortage of housing, with analysts assessing a shortfall in urban areas of over 20 million units. Retail India has huge potential for retail expansion, and the sector is growing in the region of 10% a year. Organised retailing currently accounts for only 2-3% of the market, but the sector is undergoing structural change, with leading domestic retailers going through rapid growth, format migration and consolidation. Shopping centre construction is high, but most is of poor quality, strata titled and vacancy risk is high. There is huge largely untapped potential for high quality shopping mall development. Liberalisation of FDI norms will create opportunities for cross-border investors and mall developers/operators. India continues to be saddled with a number of investment risks relating to low liquidity levels,

Tier I cities Mumbai, Delhi and Bangalore will remain the preferred option for many new market entrants, but there are fewer partnering opportunities. Mumbai and Delhi will both offer diverse opportunities; Bangalore is firmly established as a global technology hub and its economy is moving rapidly up the value-chain. Tier II cities are currently favoured – notably Hyderabad, Chennai and Pune – where there are greater partnering opportunities. These cities are proving to be highly attractive business locations, and are the increasing focus of corporate, retail and residential demand. This has not gone unnoticed by investors, and the yield gap with Tier I cities has narrowed significantly. Prime office yields in Tier II cities are in the range of 10.5-11.5%, compared to 9.5-10% in Tier I cities. Tier III cities "First mover" advantage can still be achieved in some Tier III cities, with office yields in the region of 12%. Kolkata and Ahmedabad, the largest Tier III cities, are displaying impressive economic dynamism. Of the smaller cities, we favour Chandigarh, Kochi, Mangalore, Mysore, Jaipur, Thiruvananthapuram and Bhubaneshwar. Goa offers good potential in the hotel and leisure sectors. However, whilst these cities are attracting increasing occupier interest, the investment markets in these smaller cities are likely to lack liquidity. Special Economic Zones are likely to be particularly attractive to cross-border players due to tax concessions and one-stop development approval mechanisms.

Emerging City Winners "Emerging City Winners" is Phase IV of Jones Lang LaSalle’s World Winning Cities Research, a multi-year programme designed to draw together the essence of contemporary city competitiveness. World Winning Cities examines trends that are impacting on the business and economic landscape, and how these factors are coalescing to create the rising urban stars of the next decade. Our Emerging City Winners research aims to identify the winners and losers amongst the emerging cities in India, China, and Central & Eastern Europe. This phase of World Winning Cities has evolved in response to the rapid changes that are occurring in the geography of business, where new opportunities are emerging in cities that have not traditionally been on the radar screen of the property sector.

India has a large skilled labour pool, with 2.5 million new graduates added to this pool each year

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Landscape of Enthusiasm and Aspiration We believe that the Indian real estate sector offers cross border investors with an attractive investment opportunity, underpinned by a booming and increasingly diversified economy, significant potential for rapid expansion in FDI and international trade, and maturing real estate markets across all sectors. It will be those cross-border investors who have a long term vision and commitment to India (of at least 10 years) that will be most successful A Booming Economy Since the start of economic reforms in the early 1990s, India’s economy has been growing at an impressive 6% per year, a rate that has accelerated to 8% during the last three years. The progressive liberalisation of government policies, a rapidly expanding service sector, FDI growth, a surge in exports, rising global competitiveness and increasing domestic demand have all contributed to a strong economy. India’s economic boom is set to continue, and the pace of economic growth shows no signs of slowing. With forecasts of economic growth rates of at least 6-7% per year, India is expected to become the world’s third largest economy (measured in purchasing power parity) by 2010.

Favourable Demographics India has a large, young and urbanising population:

The Rise of the Indian Economy The World’s Largest Economies in 2010

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The country’s population of 1.1 billion is set to continue to increase until at least 2030, before stabilising at around 1.5 billion, by which time India will have overtaken China as the world’s most populous country. India has a young profile. Half of its population is under 25 years, and the country’s median age is 24 years (2005), compared to 33 in China and 43 in Japan. The country is urbanising at a rapid rate of 2.5% per year. The number of cities over one million is expected to double from 35 in 2001 to 70 cities by 2025. India’s "Mega-Cities" of Mumbai and Delhi will be the world’s 2nd and 3rd largest cities by 2015.

India’s large population is now being viewed as one of its key strengths. A young and urbanising population is unleashing significant demand for products and services, and is providing massive labour market opportunities.

Economic Growth Rates 2006-2010

INDIA

INDIA

Source: EIU 2006

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Source: EIU 2006

A Large Skilled Labour Pool A large pool of highly educated and vocationally qualified people has been a major factor in attracting new business to India. The country has a total graduate population of nearly 50 million, of which an estimated 14 million are young university graduates (those with 7 years or less of work experience). This pool is 1.5 times the size of China's and almost twice that of the USA. Each year 2.5 million new graduates are added to this pool, most of whom are proficient English speakers with strong technical and quantitative skills.

Rising Disposable Incomes and a Large Middle Class With a booming economy, real annual personal disposable incomes are set to increase by 810% per year over the period 2006-10, providing a significant boost for the demand for lifestyle products and services. Median household incomes are expected to grow from US$2,000 in 2005 to US$3,200 by 2010. A large middle class has emerged, currently estimated at 120 million, half of whom are under 25 years. India’s National Council of Applied Economic Research expects a further 180 million to join the middle classes by 2010. At 300 million, it will be larger than the USA.

Significant Growth Potential in FDI Progressive liberalisation and easing of FDI norms in various sectors have paved the way for growth in foreign direct investment. Key sectors have been IT, telecoms, electronics, pharmaceuticals, automobiles and financial sectors. Nonetheless FDI is still well below its full potential, and low by global standards, estimated at less than 1% of GDP (compared to 2.4% in China and 1.8% in Brazil). Forecasters anticipate a rapid acceleration in FDI inflows, as India increasingly attracts the attention of the global investment community and further reforms are introduced. In a recent

Students at the Indian Institute of Management in Indore

survey by AT Kearney, India is ranked as the world’s second most attractive investment destination, behind only China.

Most Attractive FDI Destinations FDI Confidence Index. Top 10 INDIA

Outsourcing - the Main Engine of Growth India’s service sector accounts for 50% of the country’s GDP and has been the main engine of economic growth in recent years. Led by IT and ITES (IT Enabled Services), India has become the favoured location for business outsourcing, having witnessed large scale offshoring for more than a decade, particularly from US, UK and Australian companies. The IT and ITES sectors are currently growing at a rate of over 30% per year, and show no signs of slowing. India continues to top the AT Kearney Offshore Location Attractiveness Index by a significant margin, due to its mix of low costs, significant depth in human resources and critical mass of existing outsourcing activities. Exports will continue be important to the IT and ITES sectors, but increasingly the domestic market will be the key driver of growth, underpinned by a booming economy.

Source : AT Kearney, 2005

Offshoring Location Attractiveness Index 2005 INDIA

Source : AT Kearney

In 2004, India Space Research Organization launched Edusat, a satellite dedicated exclusively to educational purposes. Edusat will broadcast educational multimedia material to more than 200 remote and rural schools

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Strong Growth Potential in Pharmaceuticals and Biotech The growth potential of India’s pharmaceutical and biotechnology sectors is massive, and India is increasingly a source of healthcare products in emerging markets. Leading multi-national pharmaceutical companies, such as GSK, Pfizer, Merck and Novartis are already active, but the sector is expected to parallel the growth of the IT sector, with increasing outsourcing to Indian companies. Analysts see big opportunities to outsource drug discovery, and major pharmaceutical firms are looking at India as the favoured destination for clinical research and development. India’s strength, as in the IT sector, is in its low cost talent pool, whilst the recent passing of patent laws has improved the prospects of better protection of intellectual property. New office building Nagpur

The successes of the IT/ITES sectors are gradually extending to the broader economy

A Deepening Corporate Base Over 10 years of outsourcing and offshoring activities has established a deep multi-national and domestic corporate base, creating robust demand for commercial office space: The captive units of the large multi-nationals continue to spur growth - major players include GE, Prudential, HSBC, Bank of America, Standard Chartered and American Express. Outsourcing is resulting in the rapid expansion of multi-national third-party service providers such as Convergys, EDS, Accenture and EXL. But, the big trend is the emergence of Indian software companies as one stop shops for software and BPO activities. The largest, such as TCS, Infosys, Wipro and Satyam are becoming truly global brands, and are not only expanding rapidly across India, but also internationally into markets such as China, Central and Eastern Europe and North America.

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India has made significant progress in the development of its telecom infrastructure, and is now beginning to tackle its transport infrastructure



Moving up the Value Chain

Above top: New road in Delhi, Above: Indore roads by night

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India’s service sector is rapidly changing, and moving up the value chain, from provider of low cost services (i.e. basic software services and call centres) to high value IT, business processing management and high level analytics and consulting. New opportunities are emerging in engineering design, biotech research, equity research, market research and customer analytics. India is witnessing strong growth in R&D activities, particularly related to electronics and telecoms. Many of the major US and Asian IT and telecoms firms have a significant R&D presence in India, including Hewlett Packard, IBM, Intel, Cisco, Samsung, Microsoft, Oracle, Dell, Motorola, Nokia and Texas Instruments.

IT Successes Extending to the Broader Economy Whilst the IT/ITES sectors will continue to be the main engine of growth, their successes are gradually extending to the broader economy, which will result in a more diversified and robust commercial real estate sector. Several industries are being opened up by India’s reform programme, and whilst large sections of the economy remain sheltered from global competition, further economic reforms are likely: India’s financial services will enjoy strong growth driven by rising personal incomes, financial sector restructuring and liberalisation, and the growth of a more credit oriented economy. The manufacturing sector is enjoying a boom, growing by 10%+ per year, and is expected to perform well, particularly in automotive, FMCG, telecommunications and pharmaceuticals. India is one of the world’s largest food producers, which has significant untapped commercial potential – this is not going unnoticed by multi-national food chains.

• • •

Improving Infrastructure India has made significant progress in the development of its telecom infrastructure, and is now beginning to tackle its inadequate transport infrastructure. Major programmes include "The Golden Quadrilateral" project to provide an interstate road link between its four largest metropolitan areas – Mumbai, Delhi, Kolkata and Chennai. New international airports are planned for Bangalore, Hyderabad and Pune, together with upgrades and privatisations of both Mumbai and Delhi international airports. Shipping and logistics are expected to be the increasing focus of infrastructure investment, with growing

dependence on global cost efficiency. Significant capital allocations are also expected for "soft infrastructure" projects including healthcare and education. The current thrust on infrastructure development, with its accent on public-private partnerships, is likely to have a highly favourable multiplier effect on the Indian economy and real estate market.

All Leading to Rapidly Expanding Real Estate Markets Real estate is emerging as one of India’s fastest growing sectors, and all sectors are expected to expand rapidly:

Commercial Offices: Strong growth in the

allowing 51% FDI in "single brands" retail outlets. Increasingly, organised retailing will focus on smaller cities (of over 1 million population), which are still largely unexploited.

Residential: A residential boom is being fuelled by rapid salary growth of young urban professionals and easier access to finance. The average age of homeowners has fallen from 45 years to 32 years in only a decade. India has a serious shortage of housing, with analysts assessing a shortfall in urban areas of over 20 million housing units. The government is targeting 700,000 units to be built in urban areas each year.

Retail: India has huge potential for retail

Hotels: Increased business travel (due to the economic boom), higher international and domestic tourism and the emergence of low cost airlines have fuelled strong demand for hotel accommodation. But, whilst tourist arrivals have risen steadily (international tourist arrivals rose by 12% in 2005 to 3.3 million), India has so far failed to exploit its massive tourism potential, attracting only 0.4% of world tourists. The country has an acute shortage of hotel rooms. With an estimated 26,000 rooms in the branded sector, the WTTC has forecast a requirement for an additional 100-125,000 rooms over the next decade.

expansion, with rapid growth underpinned by favourable demographics, increasing urbanisation, rising disposable incomes, low interest rates, brand competition and youth culture. The sector is also undergoing structural change, with leading domestic retailers going through rapid growth, format migration and consolidation. The pace of change is likely to accelerate as foreign investment in retailing is liberalised - the government has taken the first steps in 2006 by

Logistics: A relatively dormant sector currently, logistics has good long term potential as manufacturing expands, exports grow and leading retailers enhance their logistics processes. Investment has begun to flow into logistic parks, however world class infrastructure is still lacking. Infrastructure development will need to keep pace with the transformation of the logistics markets for development interest to be fostered.

demand for commercial office space will continue to be fuelled by the rapid expansion of the IT and ITES sectors, which are growing at more than 30% a year. Employment in IT and ITES currently stand at nearly 1.3 million, and is expanding by well over 200,000 jobs per year (equivalent to an additional office requirement of more than 20 million sq ft per year). Over the medium term the opening up of the economy is expected to lead to a broader occupier base, as Indian business services expand in response to domestic demand.

A Rapidly Changing Investment Environment Traditionally the Indian real estate market has been disorganised, fragmented and governed by archaic laws; the liberalisation of the real estate industry has lagged other sectors. However, during the last few years, the Indian real estate industry has been transformed. What was once a highly fragmented business dominated by regionally-based private entrepreneurs has become a national and global business. This transformation has been fostered by significant growth in capital formation in the real estate industry and the rise of more sophisticated real estate capital markets. This

has been driven by listed and unlisted real estate companies and private real estate funds catering to institutional investors, and a heightened focus on Indian real estate by leading international property consultants and commercial banks. The recent changes in the regulatory environment, the opening up of the market to foreign investors, the growth of private equity and rising demand for higher quality real estate is gradually transforming Indian real estate into a more transparent and accessible real estate market.

Taj Mahal Hotel, Mumbai

Strong growth in commercial office space demand will continue to be fuelled by the rapid expansion of the IT and ITES sectors

Issues to Watch • • • • •

India still has one of Asia’s most difficult business environments reflecting unwieldy bureaucracy, tariff protection, rigid labour laws and relatively poor infrastructure. Despite recent investment, India’s transport and utilities infrastructure is inadequate, a legacy of decades of under investment. India imports most of its oil and gas, and is vulnerable to oil price rises. The recent discovery of oil reserves in Rajasthan may help to alleviate this constraint. Rising salaries and labour shortages in India reduce the country’s attraction for offshoring activity visà-vis other countries. Environmental risks include monsoons and droughts. Both Mumbai and Chennai witnessed severe flooding in 2005. Large parts of India are also located in seismic zones, particularly northern India.

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Opportunities Relaxation of FDI Regulations In February 2005, the Indian government further relaxed the regulations governing foreign investment in real estate. This has paved the way for capital infusion into the market and a significant weight of foreign capital is now chasing Indian real estate. Here we look at the main routes for foreign investors into Indian real estate Direct Asset Acquisitions Foreign investors can now purchase commercial development projects (under construction) over 50,000 sq m (540,000 sq ft), or plotted residential developments with a minimum size of 10 hectares. Investments are further subject to the following: Minimum capitalisation of US$10 million for wholly owned subsidiaries and US$ 5 million for joint ventures with Indian partners. Funds have to be brought in within six months of the commencement of business of the company. The original investment cannot be repatriated before a period of three years from completion of minimum capitalization. However, the investor may be permitted to exit earlier with prior approval of the Government through the Foreign Investment Promotion Board (FIPB).

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Furthermore, foreign investors are not permitted to sell or trade in undeveloped plots or raw land. "Undeveloped plots" mean where

Mumbai’s waterfront

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roads, water supply, street lighting, drainage, sewerage, and other conveniences, have not been made available. It would be necessary for the investor to provide this infrastructure and obtain the completion certificate from the local body/service agency concerned before it would be allowed to dispose of the plots. This measure has been provided in order to discourage foreign investment in speculative investment and in trading of land, without any development and/or value-addition. Direct asset acquisitions will become more prevalent, as the real estate market matures. However, with the current risk perceptions, most capital inflows will be in the form of joint ventures or developments that leverage the local partners’ expertise and market knowledge.

Equity Investment Foreign investors may purchase an equity stake in an unlisted real estate company and thereby partner in its growth plans across asset classes and cities. Significant benefits include lower transaction costs and a potentially easier exit route, via a public listing. Listed real estate companies also offer good liquid investment opportunities. With increasing confidence in the Indian real estate markets and the buoyancy in the stock market, balance sheet funding is likely to prove attractive to investors. Most investments are currently being routed into designated SPV’s (Special Purpose Vehicles) that hold the asset(s) that is being developed, with investors subscribing to the shares of the SPV, thereby reducing risk and providing for an easier exit route. Venture Capital Funds As per the Securities and Exchange Board of India (SEBI), Foreign Venture Capital Investors (FVCIs) may invest in real estate assets, within the framework of SEBI

and FDI guidelines. Indirect real estate investments are made into a pooled investment fund; such funds are usually created in partnership with domestic developers or financial institutions.

New Investment Vehicles Historically the majority of domestic real estate investment in India has been restricted to direct property ownership. Gradually however, new investment products and options are emerging; and foreign investor participation is encouraging more innovative transaction structures. The growth of pooled investment vehicles, venture capital funds and private equity funds are helping to improve market liquidity. Proposed innovations such as the introduction of tax-efficient Real Estate Investment Trusts (REITS) will further improve liquidity, open up opportunities for small-scale investors, pave the way for institutional investment and provide asset management companies with opportunities to diversify their portfolios. Major players believe that REITs could be a feature of the market as early as 2008.

Significant Improvement in Market Transparency Whilst the Indian real estate market still lacks transparency and liquidity compared to more mature real estate markets, its market structure is changing fast. Jones Lang LaSalle’s latest Global Real Estate Transparency Index (2006) shows that India has achieved one of the region’s most significant improvements in real estate transparency over the past 3 years: The significant improvement in transparency since the last survey in 2003 reflects: The increasing requirements of multi national occupiers, as well as the growing profile of international property consultancies, which has lead to the introduction of greater availability of market information. Both in published and private form, there is now more information available to participants in the market. There has also been a general improvement in market practices around the legal process. Although there have not been any significant changes in official regulations since 2003, there has been an improvement in the general market understanding around the legal processes that relate to contract enforcement and legal relief. General accounting and reporting practices have improved as the market is increasingly exposed to international capital. This has in turn encouraged local firms to match standards set by firms reporting internationally.



India: Foreign Direct Investment Norms General Route

•• •• ••

100% FDI is allowed for real estate development of over 50,000 square metres Capital must be brought into India within 6 months of incorporation of JV or subsidiary Repatriation of original investment allowed after 3 years At least 50% of the project has to be completed within 5 years Sale of undeveloped land is not permitted For plotted residential developments the minimum size is 10 hectares, with minimum capitalisation of $5 million for JV’s and $10 million for wholly owned subsidiaries

Specific Routes

•• Ventures Fund Route •

100% FDI allowed in IT Parks and Special Economic Zones 100% FDI allowed in hotels and service apartments

Pooled vehicle route adopted for undertaking general and specific route investments

Changing Developer Profiles Traditionally dominated by family-run and local players, the Indian construction and development industry is rapidly consolidating, and we are seeing the emergence of a growing number of pan-Indian construction and development companies. Increasing exposure to global capital markets is encouraging increasing transparency and professionalism in the developer community. Transparency will improve further as more developers seek public listing. New building downtown Delhi

Rising Quality of Real Estate Developers are now more attuned to the demand by both domestic and foreign companies; and tenants are driving an improvement in the quality of commercial real estate development, with the emergence of state-of-the-art campus developments. There has been a notable shift in the co-ordination of construction projects from the architect to project management providers, resulting in significantly improved delivery standards.

India has achieved one of the region’s most significant improvements in real estate transparency over the past three years





New building work in Bangalore

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Challenges Despite significant progress, issues such as liquidity and title ownership continue to act as constraints to cross-border investor activity. By international standards the sector still lacks maturity, which may dampen investor confidence over the short-term. Here we outline the key challenges Capital Market Constraints: Market liquidity is gradually improving, but real estate capital participation through capital markets is still constrained. The primary market in direct equity or debt participation is active, but the absence of REITS, Commercial Mortgage Backed Securities (CMBS) and property derivatives are hindering capital flows. Domestic institutional investment is still relatively low, and pension and insurance funds are restricted from investing directly in real estate. Exit routes therefore need to be assessed at the time of investing.

Ownership and Land Title Issues Reduce Investment Opportunities: There are

New building in Kolkata

numerous issues relating to ownership and land title, which reduce the number of investment opportunities. They include: A large proportion of land holdings do not have clear title deeds. Private land with clear title is limited. Families and individuals typically hold most private land. As a result organised dealings are restricted and title transfer is often hindered. The disposal of surplus corporate real estate often involves lengthy processes.

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Office building in Bangalore

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There is an increasing propensity, however, for investors to reduce title risk by securing title insurance, which is being structured by insurance companies.

High Transaction Costs Discourages Direct Investment: Current transaction related duties increase transaction costs significantly. Stamp duty paid by the purchaser on direct acquisitions of real estate assets can be as high as 10-12% in some states, encouraging investors to take the SPV (Special Purpose Vehicle) or company equity routes, thus reducing purchase costs to as low as 0.5% of the asset value. Stamp duty is set at state level, and further rationalisation of stamp duty is required. It currently ranges from 5% in Maharashtra (i.e. Mumbai) to nearly 10% in Karnataka (i.e. Bangalore).

Slow Development Processes: In general, development approval processes are slow and lack transparency, and can vary significantly between sectors and states. In particular, conversion of agricultural and industrial land into commercial or residential uses is time consuming and costly. For developers, this increases the attraction of Special Economic Zones, which offer single window approval mechanisms. The Urban Land Ceiling and Regulation Act (ULCRA), the historic legislation which was introduced to prevent profiteering, has been repealed in most states, but continues to constrain market development in states such as Maharashtra, Andhra Pradesh and West Bengal. Short Tenancies: Tenancy laws have not traditionally been in favour of the owners in India due to historic rental controls, although this is undergoing gradual change. Leases in the main cities are typically for a period of nine years, with tenants locked-in for only three years, thus increasing vacancy risk. However, tenant improvements are funded by the tenants, and bank loans against rent receivables are easily available.

Dissecting the Investment Opportunity Investor Activity An active domestic commercial real estate investment market has gradually emerged since the beginning of the early 2000s, in response to growing demand for modern commercial space. Since 2005, the investment market has grown rapidly, due to perceptions of strong market fundamentals with good long-term growth prospects, the emergence of specialist real estate vehicles and the participation of foreign investors. India is now on the radar screen of many cross-border real estate investors, and a substantial weight of both domestic and global capital in now seeking real estate investment opportunities in India. The current investment market includes active participation from domestic real estate funds, institutions, high net-worth individuals and local developers. Domestic debt also remains strong as a financing option, primarily in the form of construction finance as well as lease rental discounting. Cross-border investment activity is currently dominated by Singaporean and other Asian players, and US opportunity funds. A number of European players are also now looking at options to enter the market.

substantial funds to invest in real estate. Significant investor interest has also been expressed by cash surplus non-resident Indians (NRIs), primarily from the USA. HNIs are increasing their presence in residential, commercial and retail space. They mainly invest directly into real estate assets.

Domestic Developers: Domestic real estate development companies have increasingly participated in land auctions and have invested in buying land for development purposes. Most development companies participate with an equity partner / institutional fund when bidding for land parcels. Some development companies are now looking at a listing in the stock exchange as a means of securing additional equity capital to fund their growth.

Since 2005 the Indian real estate investment market has grown rapidly

There are a number of cross-border investors active in the market. Their entry has largely been through the development route or venture capital funds, and their focus so far has been on IT Parks and Residential Townships.

Foreign Developers

The domestic equity route comprises four main groups – dedicated real estate funds, institutional funds, high net worth individuals and developers:

Developers from Singapore, such as Ascendas, GIC, Keppel Land, Capita Land and Lee Kim Tah Holdings are the most active group. Ascendas, one of Asia’s leading business space providers has been active in India since 1999,

years have seen the mobilisation of investible funds by several dedicated real estate funds, such as Anand Rathi Real Estate Opportunities Fund, Dewan Housing Realty Fund, Kshitij Fund, TCGRE, Reliance Private Equity, etc. Historically, their focus has been on India’s "primary" cities - Bangalore, Delhi and Mumbai, but such funds are increasingly seeking out opportunities in "secondary" cities, such as Hyderabad, Pune, Chennai and Kolkata.

New office building in Chennai

Cross-Border Participants

Domestic Participants

Dedicated Real Estate Funds: The last two

New office building in Bangalore

Major Cross-Border Transactions - Residential

Foreign Investor

Country

Investment type

City

Lee Kim Tah Holdings

Singapore

Township

Chennai

Salim Group

Indonesia

Township

Kolkata

Emaar Group

Dubai

Township

Hyderabad

Keppel Land

Singapore

Condominium Project

Bangalore

Evan Lee & Co Pte Ltd

Singapore

Township

Vizag

Universal Success Enterprise

Indonesia

Housing Project

Kolkata

Institutional Funds: Major financial institutions

Capitaland

Singapore

Housing Project

Mumbai

such as ICICI, HDFC, IL&FS and Kotak Mahindra have all launched real estate funds, either as joint ventures or sole investors. Most institutional funds operate on a pan-Indian basis, and are increasingly looking at opportunities in Tier III cities, in order to gain "first mover advantage".

Morgan Stanley Real Estate Fund

USA

Housing Co.

Bangalore

Major Cross-Border Transactions – Commercial

Investment value mUSD

Stage

Foreign Investor

Indian Partners

Tishman Speyer

ICICI

600

Operational but investment yet to be made

Ascendas

GE

63

Operational and partially invested

High Net-Worth Individuals: India has a large

Emaar

MGF

833

Operational

community of high net-worth individuals (HNIs) and family-run businesses, which have

IREO

Panchshil

180

Committed full amount in Pune for office & residential

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New office building in Bangalore

and owns IT parks in Bangalore and Hyderabad, and is building IT parks in both Chennai and Kolkata. Ascendas launched a $350 million India IT Parks Fund in 2005 with GE Capital subscribing $US 63 million. Most Asian development companies have focused on Tier I cities, primarily in residential and commercial assets. Other Asian developers include Emaar (based in Dubai), which is developing integrated townships in India’s Tier I and II Cities. In January 2006, it announced a $US 4 billion joint venture with MGF Land, representing India’s largest real estate FDI.

Real Estate Funds: Real estate funds, including private equity funds as well as dedicated real estate funds, are increasingly becoming the preferred entry route for cross-border investors, particularly amongst US opportunistic investors. Tishman Speyer, Vornado Realty, GE Capital, Warburg Pincus, Citibank, Apollo Real Estate and Morgan Stanley are all active, mostly through JV real estate funds. Tishman Speyer, for example, formed a joint venture in April 2005 with ICICI Ventures, the private equity arm of ICICI bank. TSI Venture Funds plans to invest close to $1 billion over the next 5 years.

Sector Opportunities Suburban offices and the residential sector are likely to offer the greatest opportunities over the short term, and over the medium term opportunities will rise in the retail sector Suburban Offices Growth Drivers: With India emerging as a leading hub of IT and ITES/BPO activities, these sectors will continue to be the main drivers of suburban office demand. The IT and ITES sectors accounted for 80% of the 25 million sq ft of office space absorbed in 2005. Jones Lang LaSalle estimate a requirement for about 50-70 million sq ft from the IT and ITES sectors over the next two to three years. The suburban fringe of the main cities has emerged as the primary growth market for offices, with 75% of office development in suburban and peripheral fringe locations. This sub-sector will continue to be fuelled by a 30% + annual growth forecast for the IT and ITES sectors.

Investment Opportunities: IT Parks and SEZs: The focus of foreign investor demand is likely to be on IT Parks and Special Economic Zones: which provide attractive tax incentives for developers. With the expected termination of fiscal benefits in IT Parks by 2009, developers are likely to move towards Special Economic Zones, where developers are entitled to a 10year corporate tax holiday. The main IT parks are located in: The Bangalore–Hyderabad–Chennai "Golden Triangle" in southern India, which will continue to be the main beneficiary of the IT boom, with India’s best infrastructure, labour pools and real estate formats. National Capital Region (NCR) - Delhi has become a primary hub for IT and ITES, particularly in the suburbs of Gurgeon and NOIDA. Pune, with strong education and research institutions, has emerged as a strong IT hub. A number of tertiary IT hubs, most notably Kolkata, have emerged over the past 2 years, driven in particular by expansion of domestic software companies.



Prime Offices Yields in Major Cities Grade A Properties

Prime Yields

• • • Source: Jones Lang LaSalle, 2006

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Emerging sectors such as telecoms, financial services, pharmaceuticals and biotechnology will also boost demand for office space. Over the medium term, the further opening up of the economy is expected to lead to a broader occupier base, as Indian business services expand in response to domestic demand.

Special Economic Zones Defining Special Economic Zones (SEZ) SEZ is a specially delineated, duty free enclave, deemed to be outside the customer territory for the purpose of carrying out authorised activities. There are 14 operational SEZs in India. In addition, around 60 SEZs have been approved and are currently at various stages of development. Top: Hyderabad Cyber Towers. Above: a new housing development planned for Hyderabad. Above right: New build Mumbai

Sale and Leasebacks – One of the major trends is a general shift from owning to leasing real estate. While not universal, more corporates are evaluating investment structures that help get real estate off their balance sheets and redirect their capital to core business activities.

Prime Office Yields:





An active investment market has pushed prime yields in the NCR (Delhi), Bangalore and Mumbai down by as much as 300 basis points from 12.5-13% (in 2001) to 9.5-10.0% (as at Q1 2006). In Hyderabad, Chennai and Pune, prime yields are in the range of 10.511.5%. Many domestic investors are now looking at Tier III cities such as Kolkata in order to achieve "first mover advantage", and following the movement of occupiers to newer locations. Prime yields in Tier III cities are currently in the region of 12% - the gap between primary and tertiary cities is expected to narrow.



Increasing availability of finance - the last few years have seen the home loans market grow at an annual rate of 30%.

According to the government's 10th Five-Year Plan, which ends in 2007, the country is facing a housing shortage of over 20 million units. The plan estimates the country's housing requirement at 4.5 million units per year. The government aims to provide housing for all its citizens by 2012, requiring an investment estimated at close to $800 billion.

Investment Opportunities: Cross-border developers, including Keppel Land and Emaar, are active in the residential sector, but are focusing on the larger cities because of FDI requirements to develop large plots (i.e. over 10 hectares). Prime yields are in the region of 46%. Domestic developers are increasingly focusing on Tier III cities such as Jaipur, Lucknow, Ludhiana and Nagpur. Cross border investors are evaluating residential investments keenly as they provide a

Development of SEZ SEZs are notified by the Ministry of Commerce and can be set up by private developers or by Central/State Government, or jointly by any two or more. The zones are required to have a minimum area of 1,000 hectares of land. However, product specific zones (such a IT SEZs, Electronics Hardware SEZs, Textiles SEZs), as well as Port and Airport-based Zones can be of a smaller area depending upon the industry.

Fiscal benefits to the Developers Income Tax Incentives

•• •• • •• • ••

10 years tax holiday Exempt from dividend distribution tax Interest on long term finance tax exempt Long- term capital gains arising on transfer of shares in developers company tax exempt No MAT (Minimum Alternative Tax)

Indirect Tax Incentives Nil import duty Nil Excise duty Exemption from Central Sales Tax on purchase from DTA Exemption from service tax Exemption from tax on sale of electricity for self generated and purchased power

Residential Growth Drivers: Rising disposable incomes, particularly among young urban professionals and easier access to finance is fuelling a residential boom in India. The key drivers are: A growing middle class and increasing urbanization, resulting in acute shortages of housing units in urban areas. An increase in the rate of household formation, due to a structural shift from a joint family system to nuclear families. An increase in disposable income levels, due to a decrease in marginal tax rates and increase in total incomes. Changing attitudes to home ownership - the current average age of a new homeowner is now 32 years, compared with 45 years a decade ago. Increasing affordability of residential property, due to declining interest rates.

• • • • •

TCS Deccan Park Hyderabad

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The Big Bazaar Shopping Centre in Nagpur

shorter investment cycle, with a predefined exit to end owners of the apartments within 2-3 years. A strong underlying demand from end owners has created stable and higher returns for investors and developers. A key trend in the residential sector is the emergence of the integrated township formats. With large land parcels being available outside the city limits of the major cities, developers are moving towards large integrated developments, which have commercial, retail, residential, leisure and medical facilities (with Special Economic Zones status). Examples include Hiranandani Gardens (Mumbai), Boulder Hills (Emaar development in Hyderabad), JP Nagar (Keppel Land development in Bangalore) and Magarpatta City (Pune).

Ansal Plaza Shopping Mall, Delhi

Shopping Malls Growth Drivers: India has huge potential for

Shopping in Mumbai

The Mall Ludhiana

Investment Opportunities: On the supply side, shopping malls are a relatively new concept to the Indian market. The first malls were built at the beginning of the 2000s, but there has since been rapid expansion in shopping mall development in India’s primary cities. However, the quality of most malls is still poor by international standards, the majority are strata titled, and vacancy risk is higher than in other real estate sectors due to the large development pipeline. Shopping mall development is continuing at a very brisk pace, and new schemes are being announced by the dozen. From 25 operational malls in 2003, India is expected to have over 150 by the end of 2006 with an estimated GLA of approximately 20 million sq. ft. A significant proportion of the current stock and development pipeline are in suburban Delhi and Mumbai, raising questions about potential saturation in India’s two largest markets. Retail developers and retailers are currently focusing on opportunities in Hyderabad, Chennai, Bangalore, Kolkata and Pune. Over the medium term, organised retailing is expected to spread to smaller cities (of 1 million population and above), which are currently largely unexploited. The growth of organised retailing in the smaller cities in India (1 million plus population) is likely to throw up portfolio level investment opportunities, along with the introduction of integrated mall management services. With the emergence of professional mall management companies with a pan-India presence, there is likely to be a move towards build and lease models as against strata title. Prime yields are in the region of 10%.

Global Retail Development Index 2005: Top 10 Countries

INDIA

India has huge potential for retail expansion, and the sector is expected to grow by 10% per year. Rapid growth is underpinned by rising disposable incomes, increasing urbanisation, low interest rates, brand competition and strong youth culture

retail expansion, and the sector is expected to grow by 10% per year. Rapid growth is underpinned by rising disposable incomes, increasing urbanisation, low interest rates, brand competition and strong youth culture. Organised retail currently accounts for only 2-3% of the retail market in India (compared to up to 20% in China), but the sector is undergoing structural change, with leading domestic retailers such as Pantaloon, Shopper Stops, Westside and Big Bazaar going through rapid growth, format migration and consolidation. Moreover, VAT was rolled out in April 2005 which has brought all retailers into the tax loop, will improve transparency. Retail consultancy KSA Technopak forecast that the share of organised retail will rise to 10-12% by 2010. This represents a huge opportunity for prospective new players. The pace of change will accelerate once foreign investment in retailing is liberalised. In 2005, the government hinted that it would open up the retail sector to FDI, and has taken the first

steps in 2006 by allowing FDI in "single brands" retail outlets, allowing the more strategic entry of global brands. Foreign retailers such as M&S and Benetton have been active some time through franchises. Walmart, Carrefour, Tesco and Casino are all actively seeking local partners.

Source: A.T. Keaney, 2005

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The Geography of Opportunity India is characterised by major differences in the economic, business and socio-cultural environments between its main cities and regions. Significant variation in regional economic growth rates have emerged, leading to a widening gap between the economies and real estate markets of the more advanced regions, compared with the rest of the country The more advanced cities of western and southern India have benefited most from the opening up of the economy over the past decade, and they are expected to continue to be the most dynamic of the coming decade. These states contain India’s wealthgenerating commercial hubs, its best quality labour pools and infrastructure, and are the most successful in attracting FDI, due to their more open business-friendly environments. In contrast, large areas of northern and eastern India remain economically backward, including the two highly populous Ganges Basin states of Uttar Pradesh and Bihar (which alone contain one-quarter of India’s population).

Regions with the strongest economic growth potential are likely to be: Region: City Maharashtra: Mumbai, Pune, Nagpur NCR/Haryana/Punjab: Delhi, Gurgeon, Chandigarh, Ludhiana Karnataka: Bangalore, Mysore, Mangalore Tamil Nadu: Chennai, Coimbatore Andhra Pradesh: Hyderabad Gujarat: Ahmedabad Madhya Pradesh: Indore Rajasthan: Jaipur Kerala: Kochi, Thiruvananthapuram Goa: Goa West Bengal: Kolkata

Tier I Cities

The first choice for new market entrants Mumbai the commercial hub Delhi the political capital Bangalore the technology hub Have been the pioneers of Indian real estate growth since the late 1990s. These three cities command by far the highest international profiles and have attracted a significant proportion of FDI; they provide the largest and most qualified labour pools, the best infrastructure and have developed the most advanced real estate formats. Bangalore remains at the forefront of the global IT outsourcing trends. Delhi and Mumbai, as India’s two largest city economies, have developed a diverse range of real estate activities, and as well as rapidly expanding suburban office markets, have led India’s retail and residential development booms. Tier I cities are likely to remain the preferred option for multi-national companies entering India for the first time, and they will still be the first "port of call" for most foreign real estate investors.

Tier II Cities

Rising rapidly on the radar screen Hyderabad, Chennai and Pune Tier I are facing strong competition from Tier II cities. Business costs have increased and

labour shortages have emerged in Tier I cities, and as familiarity with India as a business location have grown, more domestic and foreign firms are now considering Tier II cities for their expansion plans, or even as their first step into India. Hyderabad, Chennai and Pune are proving highly attractive business locations, due to their competitive business environments, human resources availability, telecommunications connectivity, quality of urban infrastructure, transparency of governance and availability of real estate. As well as attracting high value IT, ITES and biotech activities, these cities are also the focus of major domestic retail players, attracted by the rising aspirations and incomes in Tier II cities. These trends are being echoed in real estate investment; Hyderabad, Chennai and Pune are the focus of increasing investor activity, and the yield gap between Tier I and II cities has narrowed to as low as 100 basis points. Some of the largest and most high profile developments by cross-border developers are in Tier II cities.

City Population

Source: Census of India, 2001

Air Accessibility

Source: Airport Authority of India, 2006

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Office Completions 2002-2006

Millions sq ft

Source: Jones Lang LaSalle, 2006

Tier III Cities

Offer growing opportunities

Science City in Kolkata

During the last two years, more firms have begun to evaluate the viability of locating in Tier III cities, and India is now seeing a gradual widening of its real estate base into a larger group of cities. This trend is being led by domestic IT and ITES companies such as Wipro, Infosys, and Satyam, and the more established foreign companies, such as IBM, Microsoft and Dell. Jones Lang LaSalle has identified 18 Tier III cities that have the potential to emerge as important real estate markets over the next five years. The most successful cities are likely to fall into two groups: Large cities, such as Kolkata (pop’n 13 million) and Ahmedabad (pop’n 5 million), which have historically lagged Tier I and Tier II cities, but by virtue of their size, labour market quality and economic dynamism, are expected to attract substantial real estate activity. Kolkata (West Bengal) has

transformed from an insular communist economy into a business-friendly IT hub. Smaller Indian cities (many with populations around the one million range), which will compete successfully for business due to superior education levels, a higher quality of life and urban infrastructure, good proximity to primary cities and their cultural and tourist offer. Chandigarh, north of Delhi designed by Le Corbusier and Kochi on the Kerala coast stand out, but cities such as Jaipur, Mangalore, Mysore, Thiruvananthapuram and Bhubaneshwar are also attracting increasing corporate interest.





Some smaller Indian cities will compete successfully for business due to superior education levels, a higher quality of life and urban infrastructure, good proximity to primary cities and their cultural and tourist appeal

Domestic funds and developers are active in Tier III cities in order to achieve "first mover advantage" and benefit from yield compression. However, many of these Tier III markets will continue to lack liquidity over the medium term.

Street and market scenes from Ahmedabad

Contacts For more information on India Investor Futures and how Jones Lang LaSalle can assist companies making high quality investment decisions in India, please contact: Vincent Lottefier, Country Head, Jones Lang LaSalle (New Delhi) Tel: + 91 11 4149 1001 Email: [email protected] Mridul Upreti, Head - Corporate Finance and Investments, Jones Lang LaSalle (Mumbai) Tel: + 91 22 5658 1008 Email: [email protected] Manisha Grover, Strategic Consulting, Jones Lang LaSalle (Bangalore) Tel: + 91 80 4118 2922 Email: [email protected] Jeremy Kelly, World Winning Cities Research, Jones Lang LaSalle (London) Tel: + 44 20 7399 5713 Email: [email protected] Tanuja Rai Pradhan, World Winning Cities Research, Jones Lang LaSalle (New Delhi) Tel: + 91 11 4149 1061 Email: [email protected]

COPYRIGHT © JONES LANG LASALLE 2006 No part of this publication may be reproduced or transmitted in any form or by any means without prior written consent of Jones Lang LaSalle. It is based on material that we believe to be reliable. Whilst every effort has been made to ensure its accuracy, we cannot offer any warranty that it contains no factual errors. We would like to be told of any such errors in order to correct them

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