Why you should be investing in commercial real estate now?

Anuj PuriJLL India

In India, real estate has always been considered a favourable investment option. However, over the last few years, the real estate market's momentum has weakened significantly - and in fact even reversed in some parts of the country. Poor economic growth coupled with high property prices have made people more skeptical about investing in real estate. Does this mean that real estate is no longer a lucrative investment option?

• Weakening Residential Rationale

It is true that real estate was one of the industries which were rather severely hit by the poor economic growth of the country. Piling inventory and escalating prices led to decrease in demand across all real estate asset classes. However, with a stable government at the Centre and the renewed sense of confidence this has infused in the industry, the outlook for the sector once again looks positive.

Generally, most people invest in real estate by buying their own homes. Residential has always been the most preferred asset class for real estate investment. The reason is that as end user investors move up in life, they can rent out their first homes, secure decent monthly rental income and acquire a larger and/or better-located home for their own use. The negative cash flow is an acceptable fact, given the appreciating value of the property. This is the typical story of most real estate investors who prefer investing via the residential route. So far, they have been successful at it.

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However, the old formula of investing may not work anymore. The escalating prices of residential properties and low appreciation levels have changed the market scenario. The risk attached to investing in residential properties is increasing. In the best of the cases, investors may still make money, but not as much in terms of percentage as the values of residential properties are already at their peak. In the worst-case scenario, investors may even lose money, as the residential property market in many parts of the country is seeing stagnation and declining capital values.

• Commercial Firms Up

For those looking to invest in real estate today, investing in a commercial property rather than residential can be a better option. Given the oversupply in the commercial real estate space, prices are currently relatively low as compared to residential property. Also, this segment holds scope for both capital appreciation and regular income through monthly rentals.

Investing in commercial space requires much larger investments than residential, and this is why commercial real estate has been traditionally been perceived as an asset class where only heavyweight HNIs or institutional investors can participate. However, that has now begun to change - many retail investors are now able to get into the commercial real estate game.

Today, those looking at commercial property investment can look at different ways to do so. One obvious option is to buy a commercial property; however, one can also buy shares of a commercial developer, or invest in a fund which focuses on commercial property. REITs, the new route everyone is now talking about, is expected to roll out soon.

So, what makes investing in a commercial real estate a safer bet at this point of time?

• The Impact of 'Achhe Din'

With the new and unarguably business-oriented government at the centre, there is a renewed sense of confidence at the corporate and global investor levels. Proposed changes in the FDI norms for the sector have helped strengthen market sentiment. Campaigns like ‘Make in India’ are fueling capital inflows, and thereby pushing up the demand for commercial real estate in the country.

• The Start-Up Boom

With more and more Indians realizing their entrepreneurial dreams, India is seeing a steady growth in start-up businesses. On the back of the renewed confidence in the Indian market, these entrepreneurs are managing to attract massive investments not only from international players but also from leading Indian corporates. This has proved to be a major factor in driving the demand for commercial real estate in the tier 1 and tier 2 cities of India.

• The Price Is Right

Average capital values in the Indian commercial real estate sector are still 25% lower than the most recent peaks seen in mid-2008. Capital values in the residential sector, however, had surpassed their previous peak by end-2011. Given that commercial rental and capital values have bottomed out considerably in most major cities in India over the last couple of years, commercial real estate is now attracting a larger share of investor interest.

• Better Returns

The rental yield for commercial property is usually 8-11%. In contrast, the yield for residential property is much lower at 2-4%. With the rising demand for office space in India, investing in a commercial property is a very good proposition. Yields in commercial real estate are not only better than in residential real estate, but also offers higher capital appreciation owing to rising demand.

• The REITs Route

Real Estate Investment Trusts are expected to be opened up shortly by the government. REITs are pooled investment entities wherein the corpus is invested primarily in completed, income-yielding real estate assets. The major part of the revenue/income generated is then distributed among their investors. The draft guidelines for trading in REITs in India have been introduced and allowed. For the very first time, there exists a tool to channel small savings into the Indian real estate sector. Not surprisingly, several owners of income-generating properties are now considering setting up REITs.

In Short

Today, investing in commercial properties has emerged as the more prudent route, especially for those who have enough equity for the down payment. The positive monthly returns promise a regular cash flow, so the investor is not dependent solely on appreciation to generate a profit.