Why should you invest in Commercial Real Estate?

Although commercial real estate has been traditionally seen as an asset class that only institutional investors or heavyweight HNIs could invest in, buying an office or retail space is no more a huge investment today. Many retail investors are now getting into the office real estate game.

Opportunities for Indian Commercial real estate in perspective :

i)   Manhattan in New York City has 450 million square feet of Grade A commercial space in stock.

ii)  London has 200 million square feet of it.

iii) In comparison to this, the entire stock of India’s Grade A office space is a tiny 270 million square feet.

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WHY SHOULD YOU invest in Commercial Real Estate ?

i) The rental yield for commercial property is usually 9-12% per annum. In contrast, the yield for residential property is much lower at 3-4%.

ii) The demand for office space in India is likely to stand at around 200 million square feet over the next five years.

iii) The possibility of diversifying one’s portfolio, the sheer pride of ownership and the benefits of the longer leases that typify commercial tenants are other reasons to look at commercial real estate investing.

iv) You do not only earn a monthly rental income but also enjoy significant capital appreciation over a period of time.

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Smaller Capital Investment Required (Reduction in Average Ticket Size)

A few years ago, the minimum ticket size of investment in commercial real estate was huge – with investors having to purchase a minimum of half a floor or more – putting such assets out of reach for small investors. But this scenario is quickly changing, with many developers – especially in cities such as Bangalore & Hyderabad – today offering much smaller units of space (as small as 100-1000 square feet) in Grade A & B buildings. Investors considering retail space can now consider a range of affordable options in free-standing high street outlets or shops in malls.

There are 3 advantages of smaller units :

i) It is easy to find tenants for them.

ii)  Lower capital investment.

iii) The premises can also be used for business by the investor himself.

Another positive development is that banks and NBFCs are willing to lend up to 60% of the value of such commercial properties as loan to investors (subject to the borrower’s net worth and ability to repay) making it that much more affordable. And in most cases, the future income accruable from leasing out such spaces can also be discounted into a lumpsum payment (or a further loan can be taken based on this income receivable) which can be reused to purchase further properties.

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WHAT TO LOOK FOR while investing in Commercial Real Estate ?

Despite the availability of more affordably priced options, investments in commercial real estate must not be taken for granted as they require quite a bit of research as below :

i)  You need to establish the soundness of the location and its demand/supply dynamics.

ii)  You should check the developer’s credentials and track record to make sure that the quality of construction and subsequent management & maintenance of property is in line with accepted market standards.

iii) You must assess the potential for infrastructure development in and around the project (in the catchment area) and also access to public transport and other basic amenities like power, water, etc.

iv) You need a knowledgeable real estate agent who can give you sound advice.

Apart from above basic points, there are other specific points to be considered based on the type of commercial property you invest in. For example, if you are investing in a retail store, you need to consider the frontage, foot-fall and the dynamics of the adjoining catchment, etc.

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In essence, if you are looking at an income producing office/retail asset, you must evaluate the following points to decide on the viability of the investment :

i)   The cash flows it can generate – this is the biggest deciding factor as it determines the yield and profitability of your investment.

ii)  Additional expenses involved such as maintenance, property tax and insurance – all these expenses will have an impact on your net yield and hence must be evaluated in detail before investing.

iii) Long term capital appreciation potential – as mentioned above, investment in commercial assets is not only for earning rental income but also for capital multiplication through appreciation of the asset.

iv) The vacancy factor of the proposed investment location – because the success or failure of the investment depends on whether it gets rented out or not.

SUMMARY

Very few of the world’s commercial real estate markets have undergone such a dramatic and rapid change in such a short span of time as India’s has. The next few years will see a quantum spurt in the services and knowledge sector, opening up tremendous opportunities for wealth creation for the retail investor in the commercial segment of the Indian real estate markets.

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By Jhashank Roy Chowdary (About the Author)