Net Absorption in Commercial Real Estate – It’s Significance & Importance
Net Absorption is an important metric to understanding the profitability, sustainability, and stability of an investment in commercial real estate.
Net Absorption in Commercial Real Estate – It’s Significance and Importance
Before we do a deep dive into what affects Net Absorption and why it is important, here is a very simple definition of what it is essentially. Considering the market conditions, location, and time remain the same, Net Absorption is the difference between commercial spaces vacated and commercial spaces taken up by tenants, companies, or businesses.
To better understand it with an example, consider 5 entities in Whitefield, Bengaluru with occupied office spaces in the order of 500, 1250, 2000, 1000, 700 sq. ft. respectively. For convenience’s sake, let’s assume the entities are named A, B, C, D, E. So, the total commercial space occupied by them in Whitefield is 5450 sq. ft. In the quarter of July-September 2021, while A, B, and E stay in their offices, C and D decide to switch office spaces. That effectively means 3000 sq. ft. of office space was vacated. C moves to office space of 2500 sq. ft. and D upgrades to a 2200 sq. ft. space. That brings the total absorption in Whitefield to 4700 sq. ft. The net absorption however would be 1000 sq. ft. (4700-3000 sq. ft.). This is a positive net absorption.
Why is Net Absorption Significant?
Net Absorption indicates the change in leased/rented space in a particular commercial real estate market or locality between two specific time periods. This comes in handy when looking at the performance of the market in a historical perspective. It helps understand the dynamics of supply and demand in commercial real estate. Gross absorption, while indicating the demand and supply, fails to indicate the changes leading up to the same.
A positive net absorption means that more space was leased/rented than was vacated. It could be due to lesser supply or more demand. This leads to an increase in commercial rent. Likewise, a negative net absorption means that spaces are being vacated more than they are being occupied. Either the tenants might be losing interest in the locality, or the market isn’t very conducive to the businesses that called it home.
Either way, from an investor’s perspective, net absorption plays a very important role. If you would care to look up the net absorption of commercial spaces over the last couple of years, you might see a lot of inconsistencies. That is primarily due to the fallout of the pandemic situation. If you want to ascertain how a particular market or locality has been historically, maybe check out the times before the pandemic. That will present a more standardized picture.
Net Absorption in Indian Commercial Real Estate Market
As of Q1 2021, a report by JLL has indicated a decrease in net absorption by 33%, Q-o-Q with 5.53 million square feet space leased during January-March 2021. Bengaluru, Hyderabad, and Delhi-NCR accounted for about 80% of the net absorption during this quarter. Bengaluru and Delhi-NCR are the markets that saw an increase in net absorption compared to 2020 Q4.
While in H1 2021, Bengaluru and Pune accounted for almost 60% of net absorption. In the second quarter of 2021, the net absorption of the office market was up by 32%. India’s net absorption was around 4.39 million sq. ft. in the second quarter of 2021. However, the quarter-on-quarter drop in 2021 was much lower than that in 2020, indicating that the market is showing improved resilience. IT/ITeS has contributed steadily to the demand of Grade A office spaces and that has led to a better scenario for the commercial real estate (CRE) market overall.
In retrospect, if you look at the ways net absorption has helped deduce the profitability and stability of the CRE market, it becomes clear why it is such an important metric in understanding the best asset and location to invest in.