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The commercial real estate space is facing a situation of a revival of demand but supply is yet to catch up. On the back of the global financial crisis, developers were not building commercial space for the past four to five years and the existing stock was getting consumed. That is why office spaces are now seeing higher rental yields, which makes it a good investment option.
The Indian economy is poised to grow at 7.3 per cent, inflation has been reined in and the manufacturing sector is seeing gradual growth. The commercial office space is gaining momentum as companies are looking to consolidate or expand due to improving business sentiment. Strong demand from the e-commerce segment, followed by the information technology and IT-enabled services sector, and the banking, financial services and insurance (BFSI) segments, has resulted in high absorption levels in quality office and commercial properties. Capital values and rental yields have held firm in the face of sturdy demand. Other active industries like manufacturing, engineering and pharmaceuticals are expected to provide further impetus to this segment.
Amit Bhatia, head, assets and business banking, Deutsche Bank India, says: “This is a good time to invest in commercial properties, given the low capital values and high rental yields. In many micro markets, commercial properties are priced lower than residential ones, while offering double the rental yields. Grade-A properties, whether in the office, retail or high street space, are bound to deliver capital appreciation and higher rentals.”
The difference between residential and commercial real estate, from an investment point of view is that rental yields are higher in the latter, says Viral Desai, national director at Knight Frank India. “In the past two years, residential real estate has seen more appreciation but it has peaked out. Office space continues to give better rental yields. In residential property, (annual) rental yields are around two per cent, while in the case of office space, it is eight to 11 per cent and picking up,” he explains.
However, capital appreciation is lower in commercial property, as there is a lot of speculative buying in residential property. Office space, on the other hand, is more driven by end-use. While a commercial space might not be as easy to sell as residential space, it is easier to find tenants for office space than for residential.
“Overall, with good quality tenants and lock-in of leases, the office space provides good opportunity for investors. With the interest rate cycle on the decline, one can expect appreciation as capital rates start compressing. Also, with Real Estate Investment Trusts (Reits) expected to hit (the market) soon, liquidity premium can also benefit from the commercial space,” says Anshu Kapoor, head of private wealth management at Edelweiss Financial Services.
If you are looking to invest in commercial real estate, here are some things to note.
It is advisable to invest in a property which is already leased out, since it will assure cash flows, says Desai. Usually, rental agreements are signed for three to five years in the case of office space and tenants are locked in for that period. And, since the tenant puts money for fit-outs, they are less likely to vacate. So, if you invest, say, Rs 5 crore in an office space, you can expect to get Rs 40-50 lakh as annual rental income.
The type of company that has leased out the property and the kind of business is also important. For instance, if it is a bank or a brand where the office address matters, the chances of it changing offices frequently are fewer. But, a company that depends more on talent or people, has higher chances of moving out.
Buy in a building where there aren’t multiple owners and a large part is still with the developer, so that maintenance is not a challenge. And, for companies that will lease out the space, a well-maintained building with good infrastructure is important. “Ideally, the area of the building should not be more than 500,000 sq ft,” Desai says. Typically, a single unit of office space could start from 2,000-5,000 sq ft and could go up to 10,000 sq ft.
This is also important, especially if for retail use. For instance, a high street or luxury brand will be willing to lease locations with good frontage, footfall and catchment areas, even if business is not very high. That is why such spaces tend to be more expensive and and as a result of this, rental yields tend to be slightly lower than for office spaces. In the case of retail or high street, annual yields could be five to six per cent, says Desai. Along with location, also check the amenities being provided, infrastructure (transport, housing) available in that area, occupancy rates in the property and in the neighbourhood, advises Bhatia.
The developer’s experience in building and maintaining commercial space, and whether private equity funds or REITS have invested in the property, are also a good indication of the marketability and potential of the project, says Bhatia.
According to Sanjay Dutt, managing director (MD), Cushman & Wakefield, the top three cities that saw good supply and demand in the January-September 2015 period were Bengaluru, Delhi-NCR and Pune. They collectively contributed 77 per cent to incremental supply and 65 per cent to commercial absorption. While one can expect annual rental yields of 10-11 per cent in Bengaluru, those in Delhi-NCR and Pune will be in the range of seven to nine per cent.
In addition to demand from companies, there is demand from the high-end fashion and food & beverage segments, due to the entry of multi-nationals, says Bhatia. “There is negligible addition of new space in this segment. Therefore, rental yields are expected to remain stable. As commercial properties are available at attractive valuations compared to the 2007 peak, an investor can expect a seven to 10 per cent yield in this segment, with some premium properties even providing up to 14 per cent (annual) returns,” he says.
Should you leverage?
Since unit sizes in case of commercial real estate are much larger than residential, amounts required for investing are also much higher. Investors must, therefore, be willing to lock in higher amounts of capital.
While there is no tax incentive for investing in commercial real estate, unlike for homes, investors can look at lease rental discounting to increase their investment capability, says Desai. Investors can take a loan against the potential rental income they are likely to earn from the property. The rent, in this case, is directly paid to the bank. This will enable investors to buy a bigger property.
Investors can also look at a loan against the property. In the case of lease rental discounting or LAP, rates vary from 11 to 13 per cent, says Kapoor. “The benefit of taking a loan is the boost in the investment return if the capital appreciation pans out. And, the loan can be structured so that all the payments are met from lease rentals received. However, one must be wary of the risk that if the tenant vacates and a new one cannot be on-boarded immediately, it will severely affect the cash flow structure,” he notes.
Amit Bhagat, MD, ASK Property Investment Advisors, says it is better for investors to do so through funds, rather than directly in commercial space. “If you invest through funds, you will be able to get the advantage of developer margin, too,” he says.
- Check developer’s background, experience in commercial property
- If there are existing tenants, check the kind of companies that have leased out the space and the business the tenants are into
- Check location, infrastructure of the surrounding area
- If borrowing to invest, do not keep property vacant for long periods
- If buying resale property, prefer one that is already leased out