Target premium office space, JLL tells SL developers

By Madushka Balasuriya

Jones Lang LaSalle is the second largest real estate brokerage firm in the world, and the largest facilities and property management service provider in Sri Lanka servicing high-end condominiums, large multinationals and corporates. I’m about to meet the Chairman and Country Head of JLL India Anuj Puri. With their office located on the fourth floor of the ICICI Bank building on Sri Anagarika Dharmapala Mawatha I pull into the parking lot. The security guard asks where I’m headed, and I inform him of my interview at the JLL office. “Sorry sir, this parking is only for ICICI Bank customers,” he tells me. Incredulously I ask where the JLL staff park. “You’ll have to ask them that,” comes the short reply.

So off I go down the road to find a parking spot, and after several minutes of scouring, I eventually nestle my car safely in front of a wall down a relatively empty side road, and trudge back to the ICICI building. Later on in my interview with Puri I ask him about the parking situation. “Big problem, big problem,” he replies. “We don’t have parking here. It’s a real inconvenience.” It is also just the tip of the iceberg. 

According to Puri, this less than optimal building sharing arrangement is an unavoidable necessity in Colombo, thanks in large to the lack of quality Grade A office space on offer. “We wouldn’t be in this building if we had an option to be in better one,” he explains. “There is nothing else. We were in the World Trade Centre, we wanted to expand further. But we were not able to find that space, so here we are.”

While there is no formal standard for classifying a building, as they must be viewed in the context of their market, there are a few common criteria. Grade A buildings are the highest quality buildings, in the best locations, are professionally managed (housekeeping, security, engineering, etc.) by companies such as JLL – this point is key, as it provides tenants a certain level of quality assurance - and thereby commands the highest rent. 

Grade B buildings are generally a little older but still have good quality management and tenants, however their location and building infrastructure are a notch down from their Grade A counterparts. Finally, Grade C buildings are older buildings located in less desirable areas and are often in need of extensive renovation.

When you consider that the WTC is at 99% occupancy and that rent increases 8-10% year-on-year, it is not wholly surprising that JLL was unable to procure the space required for expansion. However what is surprising is that this dearth in supply of Grade A buildings is in stark contrast to its demand. The demand for medium-sized office space (3,000-15,000 square feet) in Sri Lanka, especially from domestic companies, is sizeable, while the rising number of multinationals (MNCs) looking to set up shop in the country has meant an increase in demand for smaller spaces in the range of 2,000 square feet as well.

“We are finding a lot of demand coming in, not only from foreign corporates but also from existing occupiers both domestic and multinational who are already in Colombo, who want to set up business in Sri Lanka but are unable to find grade A quality office space,” reveals Puri.

The Sri Lankan office space market is typically populated with new and refurbished buildings on the outskirts of the Colombo Business District catering to larger domestic companies, while commercial buildings (such as the ICICI Bank building in which JLL are located) and residential properties cater to the relatively smaller requirements of MNCs.

“They’re either in B or C grade buildings or they’re all scattered all over the place and want to consolidate into an A grade building. There isn’t much Grade A, good quality office space. There’s only the WTC.”

Market ripe for investment

With latent demand for office space averaging around 500,000 square feet per year in and around Colombo, Puri believes the market is now ripe for investment.

“In our opinion this market can take 20 WTCs because it will be people who are in B, C grade buildings who will consolidate, while people who are fragmented will also consolidate. There are overseas occupiers who are entering SL to do business here who would want that too.”

This therefore begs the question, what is it that is holding investors and developers back from putting up superior quality office space? “I don’t think there was that much demand. I think demand started to come up in the last two to three years, while the market also started to evolve in the last two to three years.

“Another factor was the war. Even the WTC was half empty during the war. No one wanted to be in an office complex, there was only the Government in the WTC. It’s all post war that people have the confidence to occupy it – since then it’s up from 50%.”

In addition to that, Puri acknowledges that investing in a Grade A office space product is not as easy as investing in residential properties. The key difference being that unlike residential properties, office space is not sold, it’s leased. This means the asset will be represented on a developer’s balance sheet.

“You have to have a very strong balance sheet as a developer to be able to build the entire building on your own balance sheet. In residential [investments] you make it back, it funds your project; here it’s only rent. The moment you start to cut it into pieces it’s not a grade A building anymore, it’s a grade B building. 

“If you start to sell, then a super building is also classified as a B grade building. You’re just not going to be able to manage it – upkeep, maintenance, etc. – because there are like 200 different owners of that building.”

Puri notes that foreign investors would “love” to invest in Sri Lanka over more mature markets such as the US and UK, due to the higher returns emerging markets offer. However he admits there is one caveat: investors will need to see more depth in the office space market before they commit.

“There is a big arbitrage, so they are very happy to come into Sri Lanka because the returns are high. But it has to have that depth in the market; they’ll not come in and do a $ 50 million deal on that, they want to know whether they can put in a half a billion dollars. It is a massive demand, and these are people who have patient capital, they won’t look to sell that building again they only want return.”

Who are these guys? “They are pension widow funds, provident funds, sovereign funds, government-owned and sponsored funds like the GIC of Singapore, Abu Dhabi Investment Authority, Qatar Investment Authority, Canadian pension funds. So they have no urgency to exit, all they want is a yearly return of 8-9%.”

Leap of faith needed

For the depth in market to increase, however, Puri says developers in Sri Lanka need to take a “leap of faith” when it comes to the office sector.

“They (developers) need to understand that there is a demand coming in. The calibre I feel is superior here, the quality of the buildings that are being done here for the price is outstanding. I just don’t think they are able to comprehend that there is a demand of office occupiers. They think: ‘we’ll build this phenomenal building and nobody will take it’. 

“So that leap of faith needs to happen. The prime example in my mind is WTC, where you vacate and the next day somebody comes and takes up the space.”

In his interview, Puri also spoke on a variety of other topics such as Sri Lanka’s inclusion in the latest Global Real Estate Transparency Index (GRETI), Government regulations, capital gains tax, and the growth of the retail and luxury sectors in the country.

SL makes impressive debut on GRETI

Sri Lanka, Puri believes, is ahead of even India when it comes to ease of doing business, and with investment opportunities reducing in mature markets Sri Lanka has an opportunity to break ahead of the pack in emerging markets.

“GDP is on the rise, there is political stability, ease of doing business in Sri Lanka is ahead of even India, it’s a less bureaucratic environment, and it’s got a growing middle class population. The per capita of Sri Lanka is twice that of India. So you know, there is consumption, and there is wealth in Sri Lanka. 

“Fortunately for Sri Lanka a lot of that is concentrated in one city, Colombo. That’s where for an investor to look at SL they are very comfortable coming into Colombo city. On an infrastructure side, it’s much better than many of the emerging markets. You come in from the airport and it’s a smooth ride to the city, which is what a foreign institutional fund will have as a first impression.”

This is reflected in the latest Global Real Estate Transparency Index, which is put together annually by JLL. The index, which is topped this year by the United Kingdom, takes into account 130 parameters before compiling and ranks countries according to criteria such as Investment Performance, Listed Vehicles, Regulatory and Legal factors etc. Sri Lanka debuted at 69 out of a possible 109 countries, something which caught even Puri slightly off guard.

“My initial thought when we said we want Sri Lanka to come in was, you know, it will be among the 100th or 90th country because it was just making an entry into that list of 109. I was very surprised to see it come out at 69. So it’s actually beaten half the countries and come straight into that. That was very exciting.”

The reasons for that, Puri believes, are fourfold: one is the relatively clear land records available in Sri Lanka; the second is FDI rules, which have been opened up recently making it easier for investors from abroad; the third one is the evidence of foreign developers and investors who have already entered the market (“It gives a level of comfort that there are other foreign players who have come in”); and the final one is that the developers in Sri Lanka are doing a superior job when it comes to quality of their developments.

“I think the developers in SL, by and large, are doing a good job, and when you see the quality of development for the price at which is offered, I think it’s real value for money what they are offering to the consumer.”

Government regulations

“You know you can always ask the Government to do more and more. I think certainly they’re on the right track, they’re doing the right sort of stuff. Can it be more? Absolutely. If you look at the markets like Australia and US, they are very open. You can come in, you can buy and you can sell the next day, they’re very international markets. I believe that is due to their maturity and that’s the aspiration many of the emerging markets have, to get in to that. 

“But it is a journey. If you were to ask the Government today to open up everything, it would be wrong because you need to give the local investors and the local institutions an opportunity to consolidate their constitutions before you actually open it up.

Capital Gains Tax

“Many people are sceptical about Sri Lanka reintroducing the Capital Gains Tax. I haven’t been to many countries where there is no capital gains tax, so as an investor you would always want no Capital Gains Tax, but you have to balance the fiscal and financial prudence of a country to what the desire of an investor is. 

“I wouldn’t worry too much that there is a Capital Gains Tax because foreign institutional investors are used to paying Capital Gains Tax. Now the tax has to be very clear, it can’t be ambiguous. You have to have a short-term Capital Gains Tax, which can be say you’re buying and selling within 12 months, versus a long-term Capital Gains Tax. In the short-term you have a higher percentage of tax, in the long-term you have a lower percentage of tax. You have to have the indexation, because if I have kept the property for five years it cannot be that you charge from the purchase price that I made five years ago.”

The retail market

“We think there’s a huge opportunity in there. The good thing is there people have started to plan. Shangri La, Odel, Colombo Port City, John Keells, they are all planning big retail establishments. Two to three years ago when we came, we said the demand was there for retail. This year I’m excited to see three, four, five good retail schemes that are either under construction or under active stages of planning.”

“There’s enough demand from retailers that are already here and there’s enough demand from foreign retailers who want to get in here. And the propensity of people to buy…if you look at the people here, they like to shop, they like to wear good clothes, they’re out there. If I was to say, let’s watch a movie, I don’t know where to go. There is a demand for multiplex theatres. It’s just growing now, and that’s where the opportunity is; nice food courts, entertainment, it’s got bowling alleys, it’s got a kids entertainment area.

“Tourists are the guys who have nothing to do during the day, so they go to the mall. There are foreign brands, local Sri Lankan brands, eateries, a pub, a movie theatre, etc. And hospitality is also very big in Sri Lanka.”

Luxury housing segment

“Midlevel housing people know about it, affordable they know about it; luxury I think is done, there should be no more luxury.”