Commercial real estate means a property which is used solely for business purposes like providing workspaces. It is a total opposite of a property which is being used as a living space known as Residential real estate. A commercial real estate could range from a single store/shop to a shopping center/mall. These commercial spaces are usually available on a rental basis, or they are leased to tenants.
More often we find these commercial establishments in the form of office spaces, hotels and IT parks, restaurants and healthcare and educational units. They all are income generating properties
Commercial real estate needs larger amounts of capital investments as compared to residential real estate. Individuals can invest in CREs through publicly traded real estate investment trusts.
The following are the benefits offered by CREs:
- It provides a stable income.
- Lease for a longer period ranging from 5-10 years
- Bulk buying is possible leading to a low cost per unit.
- As more rental units are available in a commercial building, the investor gets more opportunities to earn.
- Price appreciation can fetch better returns
As compared to residential real estate market, where there is a thin price appreciation, commercial real estate has been growing and earning better yields. Despite the COVID-19 phase, it is likely to recover faster and prove to be a better investment option. The Budget for the year 2020-21 has been favorable and supports new startups. The offices too are re-opening in a phase wise manner, potential investors may consider this sector as part of their investment portfolio. The real estate sector was affected by the pandemic badly but is has a bright future. Work from home policies did affect the real estate sector however, the commercial buildings are required for healthcare, e-commerce and information technology in the coming years.
Why should you invest in a commercial real estate?
- Indian property market has witnessed successful REITs. Embassy Office Parks and Mindspace REITs have been two major successful real estate investment trusts. The Brookfield REIT listing was subscribed eight times. Retail investors can easily invest in this sector. Foreign institutional investors are also taking Indian real estate market as a reliable one. NRIs are showing interest in this segment as well. Debt financing norms have been eased and that makes the institutional funding in CREs more promising. Credibility of this sector has gained confidence of all types of investors. Investing in a commercial real estate is possible even for small investors. There was a time when small investors could not enter this domain and it was reserved for large investors.
- CREs give better returns than residential properties. It is 8-10 percent in case of CREs as compared to 3-4 percent from RREs. Retail, industrial and institutional properties fetch steady income. Office properties that fall into grade A earn higher returns. Commercial properties appreciate at a higher rate than the RREs. Government is encouraging businesses through various policies to boost economic growth. This will help the commercial property market to improve.
- New companies added to Indian economy are around 16,000 post lockdown phases. This shows how faster the commercial real estate too will benefit from the emerging businesses. There have been new startup companies as well as multinational companies acquiring commercial spaces. As per the RBI, the borrowings for CREs have tripled in the past six years. Once the pandemic situation comes under control, the office spaces will show a higher demand.
- Owners of CREs and their tenants are usually having a more business-like relationship unlike individual shop owners who are more protective of their possessions. In case of CREs the tenants and landlords have a professional approach.
- CREs being constantly visited by public at large need to be maintained properly. Retail tenants also want their stores to look up to date in order to run their business efficiently. Hence the owners improve and maintain the quality of the commercial premises and resultantly the capital investment gets appreciated.
- The price valuation is easier in case of CREs. Unlike residential buildings, commercial buildings can be evaluated based on the current owner’s income statement. The potential investor looks at the seller’s asking price and what he can earn by investing in the property at the area’s prevailing cap rate.
However due to some reasons described below, there has been resistance to such types of Investment-
Real estate laws, building quality, demand and supply factors, lease and deposit agreements etc need to be done extensively which is a costlier affair. Investment in a commercial property involves a huge capital expenditure. Rates of interest too are higher in case of loans for commercial properties. The loan to value ratio is very low and approximately fifty percent of the property price must be out of the investor’s pocket. The sector is highly volatile due to its link with market trends. Due to the large area and higher rentals, it becomes difficult to get tenants.
However, if you consider REITs that is, companies that operate and maintain, finance or own income generating, it would be a much safer investment option. They offer steady income and are highly liquid. They are publicly traded and hence a systematic platform for investors. This concept though new in India, is getting momentum.
Bhoi Smrutirekha Dharanidhar