Commercial property is getting hot

Investing in commercial property is now more lucrative than residential

Residential property has always been the first choice of investors wanting to capitalize on the real estate investment opportunities in India. However, after the economic slowdown in the past few years, the commercial segment is catching their fancy. Private equity investors are now buying stakes in distressed/stalled projects in partnership with big real estate developers.

Unlike in residential projects, it is generally bigger developers who build, rent and maintain commercial projects, since they require deep pockets as well as long-term commitments. Sometimes, in the case of brown-field commercial projects, small developers either cash out (partially or fully) or enter into joint development with bigger players to execute projects and maintain leased office space.

Once a commercial project is completed, the developer needs to lease out individual offices at prevailing market rates and thereafter maintain the building on a regular basis.

Better yields

Today, investing in commercial real estate makes more sense for realty investors — including retail investors. Residential market is still in a precarious position with sales of flats having risen only marginally in the past few quarters. Also, the rental yield for residential flats is lower at 2-4 per cent per annum, while commercial units can fetch as much as 8-11 per cent and, in select cases, even higher. Capital appreciation in commercial real estate can be higher too, backed by rising demand, while residential demand continues to be tepid, making it difficult to dispose of residential units at a premium. However, sometimes residential fetches high returns due to the speculative element.

IT bandwagon

The top markets for commercial projects include National Capital Region (NCR), Mumbai, Chennai, Hyderabad and Bengaluru. Due to liquidity pressures among many developers across India, market analysts believe more deals of mergers, joint ventures and consolidation are bound to occur in the days ahead — which has already been happening in the residential space since 2008.

IT companies have played a vital role in the development of commercial real estate in India in the past two decades. Cities such as Bengaluru, Gurgaon, Hyderabad, Chennai, Noida, and Pune have experienced a spurt in commercial development — thanks to heavy investments by IT companies. As the Indian economy matures, demand for commercial and retail space is set to grow.

E-commerce

With the rise in number of e-commerce companies and retail entities, investment in warehouses appears to be a promising avenue. Market analysts are pencilling an IRR (internal rate of return) of around 16-20 per cent from warehouse development projects.

The warehouse sector is bound to become a hot favourite with PE investors with the existence of favourable government policies — be it allowing of 100 per cent FDI in warehouses and food storage facilities through the automatic route or the declaration of some zones as tax-free via free-trade warehousing zones (FTWZs). Presently, almost 25 per cent of all warehouse requirements are said to be propelled by e-commerce entities.

The booming service sector in India, especially the BFSI segment (banking, financial services and insurance), has also been driving demand for commercial and retail space. Consequently, malls, multiplexes, retail, IT parks, business centres and other commercial units have witnessed higher traction. As real estate investments trusts (REITs) gradually become a reality in India, the commercial sector will benefit from these niche investments. Lock-in leases also make retail rentals a good proposition for investors because these are usually for three- to five-year periods. In the retail space, location plays a crucial role.

For example, Worldmark Mall at Delhi’s Aerocity is opposite the Indira Gandhi International Airport, near Delhi Metro’s Airport Express Line and the NH8 Delhi–Gurgaon Expressway. This connects it conveniently with Central Delhi and West Delhi, while also being linked to the business centres in Gurgaon.

A word of caution, though. Investors should be wary of developers claiming to offer investors assured returns of 10–12 per cent per annum, for, in the past, some investors were shortchanged. Investors should therefore, scrutinise the track record and past projects of a developer before opting for schemes supposedly offering higher returns.

Data provided by commercial data analytics firm Propstack reveals that commercial realty absorption, including outright purchases and leasing of offices, in the country’s top seven markets rose by 8 per cent to 5.8 million sq ft during the first quarter of 2016. Demand from BFSI, e-commerce and IT/ITeS companies played a vital role in the improvement of commercial realty transactions. Additionally, office vacancy rates in seven markets — Mumbai, Delhi-NCR, Bengaluru, Pune, Chennai, Hyderabad and Kolkata — fell to 14 per cent from 26 per cent a year ago.

Investing strategies

It is a good time for HNI investors to invest in commercial realty. They could consider four options. One, purchase a commercial property directly. Two, invest in a fund that focuses on commercial property. Three, buy shares or equity stakes of a commercial developer. Four, wait for the appropriate REITs to roll out.