Ways to initiate investment in commercial real estate

 

Real estate has always been an integral part of one’s investment portfolio, not only because of the potentially high returns but also the associated pride of ownership. But every investment in real estate does not fetch good returns. There are numerous instances where investments in real estate have turned sour for investors. But residential and commercial real estate respond differently to situations.

Residential is the preferred asset class, as demand is higher and less specific than in commercial real estate,” said Anuj Puri, chairman and country head, JLL India. Moreover, retail investors better understand residential properties than commercial properties. “Given the huge demand for homes in most cities, residential realty provides a reliable source of rental income if chosen well,” said Puri.

But if the purpose is investment, then capital appreciation is important as well. “Residential realty market is going through a depression,” said Gulam Zia, executive director, Knight Frank India. In contrast, absorption of commercial space has improved; a trend that’s likely to continue. “Rental yield is higher” said another real estate expert.

A commercial property could be a small shop in a neighbourhood, housing complex or a mall, a small office space, or even a joint investment in a bigger office space. Each of these should be looked at from different perspectives—investment amount, tenant profile, returns, exit options and associated risk.

Shops

Shops can be an entry point for a new investor. One can buy a shop in a neighbourhood market, a residential housing complex, high street area or a mall. “Returns can be 9-10% per annum, or even 12-13% if the shop is in a good location,” said Zia. Shops can be let out to be used as ATMs, retail outlets or to professionals such as chartered accountants and doctors.

While investment amount will depend on size of the property, location matters. For example, a small shop in a high street area may cost more, and rental yield could be lower, but tenant profile will be higher, vacancy risk lower, and you can enter into long-term lease agreements.

Smaller shops in malls are sold to individual investors, but can be difficult to manage and poor location may mean lesser footfalls. If you intend to buy such a space, ensure that the mall is managed by an established developer or a professional agency, even if this means capital values and maintenance costs being higher. But mall owners now prefer to lease out the space rather than selling it.

Offices

Many companies are in an expansion mode and small enterprises are setting up offices in business hubs. According to a report by real estate consultancy CBRE, “Demand for corporate office space in India’s leading cities firmed up in the second quarter of 2015…. More than 8 million sq. ft. of commercial office space was taken up across seven leading cities, translating to a quarter-on-quarter (q-o-q) increase of around 70%.”

While this may look attractive, you need deep pockets to be able to invest in good office space—2,000-20,000 sq. ft, or more. “One can expect 15-20% CAGR (compounded annual growth rate) from office space in the medium to long term,” said Anil Rego, chief executive officer and founder, Right Horizons, an investment advisory and wealth management firm. However, again, location plays a vital role. “Grade-A properties in corporate office segment offer stable investment yields,” said Anshuman Magazine, chairman and managing director, CBRE South Asia Pvt. Ltd. (Grade-A properties are those that are located in central business districts and are also well managed.)

“For the conservative investor, ready commercial office properties may be suitable as it will give steady cash flow through an ongoing rental yield, as well as expectations of future appreciation,” said Magazine.

Land parcels

Land can provide the highest capital appreciation as long as the investor has chosen the location and plot size well, has done thorough due diligence and can afford to wait for longer periods,” said Puri. Land parcels within city limits are limited and expensive, but one can also look at suburbs of metro cities. Typically, plots are not sold by established developers and you may have to approach development authorities or small developers. Going through real estate agents can be a risky approach. “Be careful about the titles since there are many fly by night operators in this segment,” said Rego.

Private equity (PE) funds

PE funds buy stakes in residential or commercial projects, by tying up with developers, usually at the initial stage of a project. They exit once the project takes off and prices appreciate. “PE funds are more for high net worth individuals as one has to invest at least a couple of crores,” said Zia. HDFC Real Estate Fund, ICICI Venture, ASK Property Investment Advisors, Kotak Realty Fund, Piramal Fund Management, Motilal Oswal Real Estate, and IndiaReit Fund Advisors are some PE funds through which one can invest in domestic and foreign properties.

Real estate investment trusts (REITs)

REITs now have pass-through taxation—the investor pays the tax and not the fund. This has made them more attractive. REITs are similar to mutual funds—money is pooled in from investors and the corpus is invested, primarily in completed, income-yielding real estate assets. The revenue or income generated is then distributed among investors.

“Retail investors with small amounts of money can look at REITs,” said Zia. “These may be available in India in a year and so. An investor may want to wait for these instruments to be launched as investing in real estate has to be done for the long term,” he added. The minimum amount that can be invested in REITs is expected to be as low as Rs.2 lakh.

Things to remember

Investing in commercial space can be complicated; good rentals depend on location, and subsequently the quality of the tenant. “One has to be careful about economic cycles, which can lead to volatility in absorption of new commercial developments. Lease rentals can fluctuate substantially based on economic cycles. Also, commercial buildings deteriorate over time and rental yields could fall,” said Agarwala.

Liquidating is also tough. “Real estate is a very illiquid asset. So, it is not at all advisable to do any sort of investment with a short-term horizon,” said Rego.

If you are the sole owner of the property, then ideally hold on to it for the long term. But keep doing the necessary maintenance so that the rentals and the value of the building appreciate or at least remain intact.

Maintenance can also be an issue for properties that have multiple owners such as a shopping complex or an office building. “There could be operational risks involving building maintenance issues and regular upkeep of the facility that may have significant impact on the rental values of a commercial property,” said Magazine. So, before buying such a property, make sure that the property’s upkeep is taken care of either by the builder or an external agency. “The ideal investment horizon is 5-7 years,” said Puri. Issues of maintenance crop up after that time and in the absence of any consensus between co-owners, the building depreciates.

For those keen to invest in real estate, commercial properties are a viable alternative to residential options. But do note that one needs financial abilities, sufficient market knowledge and longer holding power.

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