should mncs STOP PAYING RENT OVERSEAS? A Cushman & Wakefield Research Publication
august 2014
INTRODUCTION Global economic integration as an international trend may be an intensely debated subject today, but in a globalized world it makes sense for companies to expand operations beyond borders and capitalize on the substantial cost benefits and revenue gains that arise from operating in emerging markets. It is true that many companies have become cautious about such expansion following the 2008 global economic crisis, especially in the banking, financial services and insurance (BFSI) sectors. Still, investing in emerging markets means cashing in where the growth is. In turn, leading emerging markets are doing their bit to attract foreign investments in a bid to shore up growth. For instance, after having established itself as the number one
global destination for information technology – information technology enabled services (IT-ITES) outsourcing, India now aspires to be a global manufacturing base; it is also opening channels of foreign direct investments (FDI) in sectors such as pharmaceuticals. Meanwhile, China is widening avenues for its insurance sector. For these reasons, global multinational corporations’ (MNCs) investments in highgrowth markets such as India and China are here to stay and are expected only to gain momentum. However, as markets mature, we expect MNCs to modify their investment strategies, particularly how they manage their real estate needs in international markets – an important component of their total costs.
august 2014
A Cushman & Wakefield Research Publication
How MNCs manage their real estate needs in overseas markets Emerging markets are evolving markets; in these markets, value is earned when an opportunity is spotted at a nascent stage. These markets are also prone to changes in local policies and are vulnerable to global headwinds and investment patterns. In such an environment, MNCs prefer to keep their footprint as capital-light as possible. For the longer-term horizon, it is always more cost-advantageous to buy a real estate asset than to rent it, but MNCs almost always prefer to draw up a lease rather than sign a sale agreement. For them, purchasing an office means tying up large amounts of capital into assets, which they are unwilling to do because in many emerging markets, such assets are difficult to dispose of and may also be subject to high taxation. Moreover, at the time of entry, companies are unable to ascertain what scale or rate of growth their operations might assume in the upcoming years. Hence, their headcount forecasts remain fluid. As a result, these companies usually prefer to house themselves in rented Grade A buildings, relying on the flexibility that renting allows them to tailor their real estate needs at a later date.
The changing landscape of MNC strategy in India It is interesting to note that in India, until 2010, the idea of MNCs buying real estate for self use was almost unheard-of; vast majority of MNCs preferred leasing. Recently however, we have witnessed an unmistakable shift. Numerous companies such as Glaxo SmithKline (GSK) Pharma, Sanofi Aventis, Adobe and Amazon have shifted gears and bought their own offices. Having contributed 0% to total commercial asset sales in India in 2010, MNCs contributed a whopping 60% in 2012, backed by two $100 million deals. In 2013, their contribution fell to 27%, and in the first three months of 2014, MNC-led transactions accounted for 35% of total commercial asset sales. While data suggest that commercial real estate sales to MNCs peaked in 2012, this finding may be overstated by the size of two heavyweight transactions. Although some companies are now rethinking their original course of action (leasing versus buying), it must be pointed out that MNCs contribute much more significantly to commercial asset leasing (70% of the total leasing value in 2012) in major markets in India than to buying.
Why some companies are choosing to buy rather than to lease Two major global IT companies recently bought offices in Bengaluru. Both companies have had operations in India for over 10 years; they are confident of their operations, projections and potential in the country and are now tailoring their real estate requirement so they can be more cost-effective. Moreover, both companies also moved their research and development (R&D) laboratories to India from the U.K. Such a strategic move might aid a company’s decision to switch its real estate strategy as well and might prove cost-effective in the long term as rents have been increasing every year from 2011 to 2013 in most of the prime markets where MNCs have typically leased office spaces. Though rentals have been more stable this year, there are expectations that they will start increasing from next year. Capital values have also increased moderately during the period. Hence, companies stand to gain financially if they decide to deploy capital to acquire the spaces they occupy.
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MNCs in the BFSI, ITES, FMCG & Pharmaceutical sectors are among lead commercial office buyers in India & China
SHOULD MNCs STOP PAYING RENT OVERSEAS?
A Cushman & Wakefield Research Publication
CHANGE IN AVERAGE VALUES (2011 TO 2013) City
Delhi-NCR
Micromarkets
Gurgaon – DLF Cyber City M.G. Road Delhi- Connaught Place
Rents
Capital Values
7%
20%
34%
16%
Noida
15%
37%
Bengaluru
Outer Ring Road (Sarjapur-Marathahalli)
10%
9%
Whitefield
16%
8%
Pune
Hinjewadi
9%
8%
Mumbai
Bandra-Kurla Complex
11%
10%
Hyderabad
Madhapur
18%
11%
Source: Cushman & Wakefield Research
We are witnessing other companies in the IT-ITES sector make similar moves; we also expect sectors such as automobiles and pharmaceuticals to take similar steps. But this is not a one-size-fits-all strategy. The scenario is quite different when we consider the BFSI sector or the fast-moving consumer goods (FMCG) sector. BFSI companies and a few FMCG companies were first movers to India, and have operated in the country for some 40-50 years now. At that time, the corporate leasing sector had not taken off and most commercial assets being offered for lease lacked the standards that MNCs desired. Hence companies bought land and offices at historically low values; in some cases land was offered at subsidized rates by state governments for companies to “build-to-suit.” In order to suit their expansion plans, some of these companies are now moving to cost-efficient developments in emerging business districts and cashing in on their erstwhile investments by either putting assets on the block or earning rental income. Cases in point are Hindustan Unilever and Cadbury in the FMCG sector and Citibank and Standard Chartered Bank in the BFSI sector; all have been operational in India for many years now.
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august 2014
A Cushman & Wakefield Research Publication
MNC strategy in China Similar to the cases mentioned above in the IT-ITES sector of India, several pharmaceutical companies are looking to consolidate their operations with their R&D or laboratory functions in Shanghai. Specialized R&D or laboratory facilities are investment and time-intensive; hence, in order to better control future costs of the facility, it may make more sense to purchase, especially if the business is established and stable. Companies are relocating out of central business disctrict (CBDs) to peripheral regions to better accommodate their real estate needs. With limited availability of space in CBDs, new development areas can offer companies opportunities to potentially purchase at a lower cost (up to 30% lower in some cases). Typically MNCs in Shanghai require over 10,000 square meters, which consist of an office, a showroom, a lab, a manufacturing and/or R&D unit. In Shanghai, there are a few “business park” areas that cater to MNCs, especially those looking to establish a larger (10,000 square meters or over) headquarter and/or an office/R&D location such as Caohejing Hi-Tech Park, Fenglin Life Sciences Park, and Zhangjiang Hi-Tech Park. Pharmaceutical companies such as Pfizer Hai Zheng (Chinese partner of Pfizer) and Novartis have recently bought space in these parks. In addition to these business parks, other areas within Shanghai have been designated by the government as places for MNCs to set up headquarters. The Xuhui Bund Area and the former Expo Area are two examples of this type of location. In such locations, depending on the size of a company’s tax contribution, it is possible to receive tax incentives. However, it must be noted that tax incentives are considered on a case-bycase basis. Another key factor that may be encouraging U.S.-based companies to switch from their real estate “leasing strategy” to a “buying strategy” is the U.S. taxation policy. Corporate profits earned outside the U.S. are not subject to federal taxes unless they are brought home. Several companies choose not to pay high taxes and are hence re-deploying profits earned in emerging markets into international operations; some of these profits are likely being invested in real estate properties, which also offer significant returns. According to Bloomberg News, General Electric, Google, Johnson & Johnson, Apple and Microsoft are among those companies that chose not to repatriate earned profits as of March 2014.
SELECT MAJOR OFFICE PURCHASES BY MNCs Location
Company
Sector
Space Purchased (millions of sf)
Investment Size (US$ millions)
Hong Kong
Citibank
Banking
0.51
700
Hong Kong
Manulife
Insurance
0.51
580
Shanghai
Novartis
Pharma
1.3
NA
Shanghai
Pfizer Hi Zheng
Pharma
0.07
45
Mumbai
Citibank
Banking
0.3
194
Bengaluru
Global IT Company
IT-ITES
0.25
28
Bengaluru
Global IT Company
IT-ITES
0.7
97
Hyderabad
Cognizant
IT-ITES
0.25
18
Compiled by C&W Research
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SHOULD MNCs STOP PAYING RENT OVERSEAS?
A Cushman & Wakefield Research Publication
FACTORS THAT GOVERN THE LEASE VS BUY DECISION
MNC strategies in other APAC markets Not all markets offer value for money for MNCs; a case in point is Hong Kong. The economies of Hong Kong and Singapore are led by the BFSI sector, and with limited land, these cities quote amongst the highest rentals globally. Examples of MNCs buying assets are few and far between in both cities, simply because they are perceived as expensive markets. However, last year Canadian life insurance company Manulife bought a US$ 580 million property in Hong Kong. More recently, Citibank purchased a 21 floor Grade-A office tower in what is being touted as a landmark deal for a whopping US$ 700 million. The lack of supply in Hong Kong has been a challenge for many large occupiers. It is not surprising that these large en-bloc transactions have been driven by end users, capitalizing on the opportunity to consolidate and achieve efficiencies both from a cost and operational standpoint. Greater Central office rents remain the highest in the region, even if they are more than 20% down from their peak levels in 2011; while rents in Kowloon, even if they are easing, are close to their all-time highs. Nonetheless, companies that wish to buy assets in both cities are increasingly Chinese firms, which are more entrenched in the region. For instance, in Hong Kong, Chinese companies contribute about 80% of capital transactions. While the number of Chinese companies investing in Singapore’s commercial real estate may not be as high as that in Hong Kong, their increasing presence and interest in the country’s capital market transactions, mainly in strata-titled offices, have been notable in recent years. Singapore bucks the trend seen for MNC’s seeking owner occupation options in India and China. The country is known to offer good quality office and industrial spaces at reasonable costs. Future supply is expected to be adequate for future expansion without significant shortages or surpluses, which can lead to rental spikes. Thus many incoming occupiers choose to lease rather than own. As one of the key regional hubs in Asia Pacific, coupled with the country’s robust financial system and transparent compliance regime, Singapore is attractive to domicile regional and global headquarters. If China or India is the present, perhaps the Philippines is the future. The economic trajectory of the Philippines is nascent compared to India and presents great opportunities for global giants. The country is an investment destination for global financial and insurance companies. Financial institutions such as Citibank and J.P. Morgan occupy large spreads in the Philippines, but they currently follow a rental strategy. However, just as the purchase of assets has became a reality in India only recently, so this strategy may take hold in the Philippines after companies complete a few cycles of operation in that market and feel more confident about growing in the region. Of course, supportive policies also need to go hand in hand.
Duration that a company wants to stay invested in a country
Clarity with which a company can project its future growth and expansion plans
Existing taxation laws of origin country applicable for profits earned abroad
Policies of host country; ease of acquiring / disposing assets and winding up businesses
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SHOULD MNCs STOP PAYING RENT OVERSEAS?
august 2014
A Cushman & Wakefield Research Publication
Leasing versus buying: the future As noted above, there is no one-size-fits-all rule of thumb for MNCs to find real estate solutions. The real estate needs of MNCs will be strongly governed by factors such as business tenure (is a company a new entrant or has it been operational for a few years or cycles?), local market dynamics, ease of transacting (buying as well as selling), local taxation, property management, etc. India, China and the Philippines are markets that offer attractive yields and prospects for good capital value appreciation; companies stand to gain if they invest in these markets sooner rather than later to reap potential benefits, provided currency risks are managed and minimized. In order for companies to confidently buy assets, they need to be entrenched in markets and also plan to stay for the long term. Today, consolidation of front-end activities and R&D is driving many IT-ITES and pharmaceutical companies to purchase premises. Going forward, we expect the automobiles sector to follow similar strategies in India. The U.S. tax system also induces companies not to repatriate profits. Additionally, emerging markets are highgrowth markets that are increasingly contributing to the MNCs’ balance sheets; hence, they need to reinvest profits to rake in earnings growth on a more long-term basis. Meanwhile, countries, including India and China are opening doors and making it simpler for companies to set up shop. In our view, first-time entrants will still choose to lease premises in Asian emerging markets, but we expect increased traction of commercial sales led by those MNCs that have successfully run operations for a few years in specific emerging markets. Going from leasing to buying will be a means of consolidation for those companies and will present attractive opportunities.
For more information about C&W Research, contact:
Sigrid Zialcita Managing Director, Research, Asia Pacific +(65) 6535 3232 sigrid.zialcita@ap.cushwake.com For more information about C&W India, contact
Sanjay Dutt Executive Managing Director South Asia +(91 22) 6771 5555 sanjay.dutt@ap.cushwake.com
SIDDHART GOEL Director, Research, India +(91) 22 6657 5555 siddhart.goel@ap.cushwake.com
Priyanka Ghosh Analyst, Research India +(91 22) 6771 5555 priyanka.ghosh@ap.cushwake.com
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