Real Estate

Commercial Property Investment is a High-Adrenaline, High-Returns Game

Buying an office or retail space is a huge investment, which is why commercial real estate has been traditionally seen as an investment avenue for only institutional investors or high net worth individuals. However, things are changing. Many retail investors are now getting into the office real estate game.

INVESTMENT ROUTES

There are three ways to invest in commercial real estate: buy office space directly from a developer, buy shares of a commercial developer from the stock market, or invest in a real estate fund focused on commercial real estate.

Many developers, especially in cities such as Mumbai, are today offering smaller units of space (as small as 500-1,000 square feet) in Grade A buildings. This is in sharp contrast to the scenario a few years back, where only much larger units were available, making it tough for a small investor to invest in office real estate. Investors looking at retail space can now consider a multitude of affordable options in free-standing high street outlets or shops in malls.

The advantages of smaller units are two-fold — it is easier to find tenants for them and the premises can also be used for business by their owners if they happen to have an entrepreneurial bent of mind.

Today, even professionals like doctors, auditors and lawyers are buying commercial properties for investment and self use. Of course, HNIs also continue to plough huge amounts of money into high-ticket commercial properties in the quest for yield. Private bankers and wealth management firms confirm that their clients have actively started investing in commercial properties after staying away in 2009 and 2010. These investors have bought into commercial properties because they seek assets that can protect their portfolios from inflation and stock market volatility. On their side, banks are willing to lend up to 50% to 60% of the LTV to buy commercial properties, subject to the borrower's adequate net worth and established ability to repay.

WHAT TO LOOK FOR

Despite the availability of more rationally priced options, investing in commercial real estate is most definitely not child's play. It requires forethought, research and planning.

LOCATION: Investors need to establish the soundness of the location and its demand/supply dynamics. If they do not engage in sufficient research, they may end up buying into micro markets which have or will have high vacancies.

ECONOMY: They need to ensure that the economy, job market and population growth in the market is healthy

DEVELOPER: They need to check the developer credentials, potential for infrastructure development, access to public transport and quality of property management in the project

ADVICE: They need a knowledgeable real estate agent and a lawyer who can give them sound advice

DYNAMICS: If they are investing in a retail store, they need to consider the frontage, foot-fall and the dynamics of the adjoining catchment

AMENITIES : Entrepreneurs who wish to buy commercial real estate for self use should ensure that the amenities in the project match their business needs If an investor is looking at an income producing office asset, he should look at the break-up of cash flows; the vacancy factor; expenses such as maintenance; property tax and building insurance; lease term, lock-in period and expiry dates; long-term capital appreciation potential; and refurbishment, refinancing and repositioning potential.

WHY INVEST?

The rental yield for commercial property is usually 9% to 12%. In contrast, the yield for residential property is much lower at 3% to 4%.

The demand for office space in India is likely to stand at around 200 million square feet over the next five years. Post the GFC, the prices across most markets dropped around 35% to 40% and have bottomed out in most markets, offering investors a good opportunity to buy into commercial real estate. Last year, the demand for office space across India was 30 million square feet — 50% higher than it was in 2009. The possibility of diversifying one's portfolio, the sheer pride of ownership and the benefits of the longer leases that typify commercial tenants are the other reasons why an investor should look at commercial real estate investing.

Remember, you do not only make a profit on the sale of appreciated commercial property — the rental cash flows of a well-located office or shop space are considerable. Unlike with a residential property, the income that can be generated from commercial property is what determines its value. In other words, the capitalisation rate is actually the measure of the demand for the property. For those who do their homework well, investing in commercial property is a high-adrenaline and high-returns game.


Ramesh Nair, Managing Director – WEST INDIA, Jones Lang LaSalle India