Commercial Real Estate Investments


Real Estate – Commercial


Welcome to the second of two chapters on Real Estate investments.

In this chapter, we look at the Commercial Real Estate market.


What is Commercial Real Estate?

Commercial real estate, for those of you who do not know what it is, refers to shops, offices, office buildings, malls, and commercial buildings.

The best thing about commercial real estate is that unlike residential investments where the minimum investment amount will be around Rs. 15-20 lakh at the very least, here an investment of even Rs. 2-3 lakh can make you the owner of a commercial property. On the flip side, the paperwork and the maintenance challenges are more for commercial than residential real estate.

The sector has seen an uptrend since bigger investors have shifted their focus from residential real estate to commercial properties. Specific segments within commercial real estate such as warehousing, offices and industrial properties are seeing strong numbers.

The returns are of two types: Rental Income and Property Value Appreciation

The Indian real estate market has also seen the emergence of Real Estate Investment Trusts (more commonly called REITs). These are companies that own or finance income-producing real estate across a range of property sectors. The objective is to channelize funds into operational management or ownership of real estate properties and generate income for investors.


Types of Commercial Real Estate Investments

There are two ways you can invest in commercial properties. The first is to make direct investments and the second is through REITs.

Direct Investment

You can invest directly to become the owner of the property. But keep in mind that you should have more knowledge about the sector you are investing in. Let us first look at the factors you need to understand before you make a direct commercial real estate investment.

Location, Location, Location

Location is the most important criteria when it comes to commercial real estate. Both the rent you are likely to receive and the future appreciation in value depend on the location. Experts suggest that you look for locations where vacancy is considerably less. Around 5% vacancy seems to be the limit.

Such an area should have a limited supply of properties and profitable businesses as tenants. This will mean new tenants will be more willing to pay higher rent.

Demand and Supply

This is critical as more demand and less supply means you will get better rents and also be able to sell off the property much more easily. Here you ought to see the micro-market. Sometimes an area may have more demand overall but certain pockets will see less demand and this will mean less rent and even months of vacancy. The exact opposite may also happen where there may be more demand than supply in the entire locality except for a certain pocket where demand is more and supply is limited.

An important point to make here. Less demand means your property will likely stay vacant for some time which may lead to deterioration of the precincts as what happens to any vacant property.

Approvals and Clearances

You also need to ensure all civic approvals and clearances are in order. There are quite a few that need to be met from those that were needed at the time of construction to those needed after completion but before leasing.

Quality of Property  

Better quality buildings will always attract a better quality of tenants and get rented first. You are also more likely to get higher rents, better tenant retention and faster capital appreciation. Tenants like multinational corporations always look at the quality and are willing to pay a premium for such properties. These properties are also in demand in the market and you are likely to get buyers much faster.

Quality of Tenant

Having a good tenant can significantly increase the value of a commercial property. To illustrate this, here is an apocryphal story from the commercial real estate market in Delhi NCR.

When the property developer DLF could not find any interest among MNCs for one of its premier commercial properties in Gurgaon, it approached Microsoft and pitched them an entire floor of the property at a nominal rent. Microsoft accepted the deal. And as a result, other companies also choose to rent their offices at that property. But unlike Microsoft, they paid the standard and even premium rent. Within a few months, the entire building had been lent out. The building in question? DLF’s CyberGreen property in Gurgaon.

Even for smaller properties, having good tenants makes sense as they pay rent on time, are willing to pay higher deposits, stay for a longer duration and ensure the property is maintained well.

A good way to check this is to look up the other tenants in the building. Unless you are buying a shop at the nearest marketplace, checking out the other tenants in the area or nearby buildings gives you a better understanding of what you can expect.

Rent or Lease Structure

Commercial leases are very different from residential ones. They are usually structured in multiples of three or five years with rental price hikes allowed only once a specific period ends (three or five years). Moreover, in most cases, the landlord cannot ask the tenant to vacate though the tenant can leave at any time, after an initial lock-in period. The longer the lock-in the better is the rental value of the property.

Parking

Parking is becoming quite a problem and any commercial complex that does not have adequate parking will see less demand and lower footfall.


Indirect Investment

Indirect investment in commercial real estate is through REITs. As mentioned, these companies own or finance real estate across a range of property sectors. The focus is to earn income by managing the property, by rental income or by both.

As of now, there are limited REITs in India, though the market is likely to improve as more financial companies look at this as a business opportunity.

One can also say that you can invest in shares of real estate companies or mutual funds but those are not real estate investments in the correct sense.


Summary

Commercial real estate is a good investment option if you have some idea about real estate investments. There are quite a few factors you have to keep in mind but once you get the hang of it, then investment returns can be anywhere between 8-10% on average.

If you want to play it safe, then REITs are a good option. Granted the options are limited but the presence of these businesses in the sector brings in more investment avenues for you and you ought to have a look at their returns before you make any direct investment.