To date, few foreign institutional investors have been able to gain a foothold in Indian retail real estate. In 2007, Siddharth Yog, founder and chairman of the Xander Group, created one of the earliest subcontinental retail property investment platforms, Virtuous Retail South Asia, to which Dutch pension fund manager APG has committed $450 million. The company now operates four malls in the larger Indian cities with two more under construction – a portfolio of around 8.3 million square feet. He shares his insights into a rapidly growing market.
PERE: What is the investment opportunity in Indian retail real estate?
Siddharth Yog: India is very much a nascent retail market. Organized retail is still a very small percentage of the economy. Even compared with other emerging economies like Brazil, India’s organized retail space per capita is tiny. However, it is growing very rapidly now that the government has opened up the retail and real estate industries to foreign investors. It’s one of the last big untapped relatively virgin consumer markets in the world. Total annual retail spending is worth around $600 billion, and only about 10 percent of that is in the organized sector, including online retail, but that part of the market is growing at 20-30 percent a year or faster.
In developed economies, many shopping centers are dying or are already dead, but even in those countries retail is being reinvented. In India and other developing locations, that reinvention has already taken place and it provides the starting point. It’s like the way India skipped the landline phase and moved straight to smartphones. Western malls are incorporating more food and beverage space and more entertainment, but in India you wouldn’t have a retail center of any consequence without a multiplex cinema and a massive food court.
In the US or Europe, a family can go to stadiums, public parks or museums at the weekend. In India public places are often poorly maintained, security can be a problem and the weather is not conducive to non-air-conditioned environments. The default entertainment option, especially for families with young kids, is to go to the mall. There is a growing middle class that wants entertainment but has nowhere to go. For those reasons, bricks-and-mortar retail will continue to grow rapidly in India, but it will have to be married with the experiential economy to make it successful.
PERE: Is it possible to build scale quickly?
SY: It’s extremely difficult, but in some ways that represents the other side of the opportunity because there is a premium for supply. Until two-and-a-half years ago foreign investors were prohibited from buying existing retail real estate in India, but there are very few modern retail assets that you can buy anyway. I could perhaps count the good shopping centers on the fingers of two hands, plus maybe a few more. The bigger opportunity is to develop. Execution is notoriously difficult, but if you succeed there is a huge execution premium. If you could build a portfolio at scale of good quality assets in the better locations in the main cities you’d have a really big moat around your investment.
“Execution is notoriously difficult, but if you succeed there is a huge execution premium”
There is no real national retail platform or chain. The largest retail owner operating in India has eight centers so the market is very local. If you can become a pan-Indian player with a presence in good locations in the top 10 or 12 Indian cities you’re going to be a very attractive business counter-party for the international retailers that want to enter the market. The biggest challenge international brands have coming into India is the lack of quality real estate. It is very difficult for them to roll out 10 or 20 stores and create a viable business
PERE: Why is it so difficult to develop malls in India?
SY: Any of these assets have to be at least 500,000 to one million square feet in size and finding sites of 5-10 acres in dense infill locations is a challenge anywhere. In addition, because of the way the Indian real estate market is structured a large part of the value of the project is in the value of the land so you are forced almost to build more than you need. In retail you cannot go vertical beyond a point, so that poses a design challenge, and means you have to bring in other users to optimize the use of space. Because it is still developing it can be a hairy market to operate in. Planning permissions, development and construction take much longer. It can be very bureaucratic, although the government is attempting to change that, and there are all the challenges of working with players that are not necessarily very sophisticated.
PERE: What kind of returns can investors expect?
SY: Yields need to be reasonably attractive and are in the early teens whether you are developing or buying. You would then hope to see upside from de-risking or cap rate compression or by participating in sales growth. If you structure leases so that the landlord takes a percentage of the revenue then with sales growth running at 15-25 percent that is an attractive proposition for an institutional investor because it offers them a dividend payment and also growth – it’s like a bond with an equity kicker. Then there would be a portfolio-level premium because execution is so difficult and the opportunities to buy a portfolio of quality retail assets in India are very limited.
This market will not suit everyone, though. Investors in fund structures with four to six-year time horizons will struggle to wrap their arms around this because it requires at least a 10-year time frame especially for development, and the opportunities for buying existing assets and upgrading them are few and far between. If you’re looking for short-term opportunistic returns this may not be the asset class to invest in at this time.
PERE: Are there any tax or regulatory issues investors should be aware of?
SY: A few months ago, capital gains tax at a rate of 10 percent was introduced. Investors will take that into account, but in general they prefer predictability so I see that as a positive, not a negative. The retail sector is still not fully open to foreign investment. Many states do not allow certain types of foreign retailer to come in. That is changing but it will take time.
PERE: How important is a local operating partner?
SY: When we first decided we wanted to invest in Indian retail we couldn’t find an operating partner there, so we sponsored Virtuous Retail as a wholly owned platform to develop, own and operate branded shopping centers. There are very few retail service companies that could come in and run your center beyond a few small, boutique outfits which are just starting out, so investors need to bear in mind that they’re very likely not just taking development and leasing risk, but also participating in the retail space as an operator. Other investment managers are seeking to create operating platforms, and as they do so the market will mature, but cracking that requires a lot of training and development of people and as an operator you have to be on the ground, in the weeds, day after day and hour after hour.
Given the challenges that are evident for the retail real estate industry anywhere in the world, amplified by the execution challenges in India, this market is not for the faint-hearted. You need a huge amount of patience. You are investing in retail, not just in real estate, and that has to be at the back of your mind in everything you do.
This article was sponsored by Xander Group. It appeared in the Investing in Retail supplement to the July 2018 edition of PERE magazine.