The Best of Times for Commercial Property Investment

Accommodation Times News Services

office spaceBy Anuj Puri, Chairman & Country Head, JLL India

In India, real estate has traditionally been considered a favourable investment option. However, over the last few years, the realty market’s momentum has weakened significantly. In fact, it has even reversed in some parts of the country. Poor economic growth coupled with high property prices have made people more sceptical about investing in real estate. It is one of the most severely-hit industries due to these reasons. Piling inventory and escalating prices led to decrease in demand across all real estate asset classes.

  •    Weakening residential rationale

With a stable central government, outlook for the real estate sector once again looks positive, and has resulted in a renewed sense of confidence in this industry. However, escalating residential property prices, low appreciation levels and increasing risk attached to investing in residential properties have all contributed towards a weakened confidence in this asset class, which was otherwise, the most preferred one for investors as well as end users.

As home buyers move up in life, they generally upgrade to a larger and/ or better-located home for their own use. They may want to move into a new house and sell out the first one in order to secure an appreciation on their capital value. Alternatively, they may decide to hold on to their selling decision and rather rent out one of the two houses for a steady rental income. The yield rates have always been low but home buyers got a good capital value appreciation on their property.

Until the last few years, the year-on-year rate of growth in prices was greater than the corresponding inflation rate. That is hardly the case now. In a best-case scenario, an investor may still make money though not at a good growth rate as the values of residential properties have already reached their peak. In the worst-case scenario, investors may even lose money as the residential property market in many parts of the country see stagnation and declining capital values.

What could investors do in the current scenario? They could consider investing in a commercial instead of residential property.

  • Office spaces firm up

Given the oversupply in commercial real estate, prices are currently relatively low as compared to prices of residential real estate. Also, this segment holds scope for both capital appreciation and regular income through monthly rentals, in case of shops.

Investing in commercial spaces requires much larger investments than residential spaces, and this is why commercial real estate has been traditionally perceived as an asset class where only heavyweight high net-worth individuals (HNIs) or institutional investors can participate. Also, developers of offices and malls have always preferred to sell or lease bigger spaces and avoided catering to retail investors. However, that could change soon with the Real Estate Investment Trusts (REITs) coming in play. Many retail investors would be able to get into the commercial real estate game through REITs.

A new format being offered by some developers, these days, allows retail investors to get into commercial real estate. The former are building smaller offices and directly selling them off to smaller firms or retail investors instead of preferring to lease out bigger spaces to multinationals and larger firms or sell to HNIs and institutional investors. These developers offer world-class buildings and sell out to smaller firms, traders, doctors, law firms, accounting firms, etc.

The other obvious option for HNIs is to buy a commercial property. One can also buy shares of a commercial developer or invest in a fund, which focuses on commercial property.

  •  REITs – a game-changer

REITs are expected to be opened up shortly by the government. For the very first time, there exists a tool to channel small savings into the Indian real estate sector. 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.

Not surprisingly, this model has found favour across the board and several owners of income-generating properties are now considering setting up REITs. They are doing their homework on how to get returns from this investment channel. There are tax leakages though, impacting the returns, which need to be studied before participating in this instrument.

What else 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 strength market sentiment. Campaigns like ‘Make in India’ are fuelling capital inflows, and thereby pushing up the demand for commercial real estate in the country.

The pan-India net absorption during 2014 was up by more than 11% and reached 29.9 million sq. ft. Bangalore’s extraordinary performance along with increased q-o-q contributions from Pune, NCR-Delhi and Hyderabad helped to achieve such robust level of absorption. The overall vacancy also rate fell to 17% in 4Q14 from 17.5% in 3Q14 with Delhi-NCR remaining around 27.8%; followed by Mumbai (20.4%) and Bangalore (8.2%) due to strong demand.

 

  •   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-I and tier-II 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%. If the capital value appreciation is not taken into account for residential property and only the yield is compared to commercial property, it stands much lower at 2-4%. With the rising demand for office space in India, investing in a commercial property is a 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.

 

Ø  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.

Market Readings

A total of 35.6 million sq. of office space is expected to become operational in 2015. In 4Q14, 31 office projects encompassing 6.5 million sq. ft. of office space commenced operation, taking India’s total operational stock to 405.9 million sq. ft.

During 2015, we expect another 30 million sq.ft. of fresh absorption of office spaces in the country. This is expected due to the robust pre-commitments in many under-construction projects in various cities and overall positivism among the office occupiers.

Supply is also likely to increase in 2015 to about 35 million sq.ft. with several projects at advanced stage of construction. Maximum contribution in completions is expected from Delhi (9.3 million sq. ft.) followed by Mumbai (7.4 million sq. ft.) and Bangalore (7 million sq. ft.).

Mumbai and Delhi are expected to see slightly slow growth in rental in a range of 2-3% during 2015 while cities such as Bangalore, Chennai and Pune will see relatively better growth in rental in a range of 4-7%. Higher growth in rental in Bangalore, Pune and Chennai is due to their low base and also stronger demand scenario expected in 2015.





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