Diversification Series 2 - Investment in commercial real estate

Higher returns over long term, tangible investment and good diversifier for the portfolio makes real estate investing as one of the most attractive option in India.  Residential is the most preferred option as it offers sense of safety, appreciation in the long run and...

Diversification Series 2 - Investment in commercial real estate

Higher returns over long term, tangible investment and good diversifier for the portfolio makes real estate investing as one of the most attractive option in India.  Residential is the most preferred option as it offers sense of safety, appreciation in the long run and in case of the second home it also offers passive income in form of rent. Despite the outbreak of the coronavirus in 2019, the residential segment in India got a boost due to lower interest rate scenario in the economy, cut in the stamp duties, property prices been stable or seeing minor corrections and the work from home set up leading to people seeking large homes. But apart from aiming at rental income from the second home. Investors with surplus capital to invest can diversify within real estate by considering investment in the commercial properties or Real Estate Investment Trust (REITs). The article explains both these investment options in detail.  

Investing in the commercial real estate

Investment in the commercial real estate is often looked upon as the most difficult choice in India.  As the decision to buy a commercial property involves due diligence of the location, lease structure, tenant profile, valuation, quality of the construction. Moreover, it involves choosing from wide range of options of different sizes like small shop, office, day care centres, movie theatres, parking lots, condominiums, industrial floors, warehouses, and retail spaces owned by retail joints like Big Bazaar, Dmart etc. Investment in the commercial real estate also calls for understanding the legal aspect, taxability and higher ticket size. Hence, the investment remains restricted to high-net-worth individuals (HNIs) and ultra-high net worth individuals (HNIs). With the economic revival and business activities gaining pace in 2021 and start-up boom commercial space looks at a sweet spot. According to Jones Lang LaSalle (JLL), India’s net office absorption stood at 5.85 million sq. ft in Q3 2021 (July-September), a jump of 48% when compared to the previous quarter and an 8% Year-on-Year (YoY) growth in major cities. Net absorption comprised of new leasing in completed buildings and pre-commitments in buildings which became operational during the time being reviewed. It excludes exits/terminations, churns, renewals, and pre-commitments in the future supply. The leasing activity was driven by the manufacturing sector but yet to reach the pre-pandemic levels.  But the strong macroeconomic cues, rapid vaccination may boost the leasing to pre-pandemic levels in 2022 provided there is no lockdown and new virus outbreak. Given the brighter prospects, it is important to understand both merits and demerits of the commercial real estate as listed below:

Given the tedious process and huge investment amount involved in case of commercial real estate, investors can consider fractional ownership and REITs.

Fractional ownership makes it easier for the HNIs and even at times for the retail investors as affordable properties are selected after thorough research and helps investors to come together to collectively own a high value property. This results in lower entry costs and after investment investor continue to earn higher appreciation and potential stable income in form of rent. Investors can build a diversified portfolio and invest in different properties spread across different locations.  

Real Estate Investment Trust (REIT) are the investment vehicle that owns, operate and finance the portfolio of the income generating real estate assets mainly apartment complexes, hotels and shopping malls, office buildings. Just like a mutual fund which pools money from the investors and in return gives units. REITs is created by trust who transfer ownership to trust and investors in return get ownership of real estate assets. Regulated by SEBI, the first REITs came in 2019 in India and currently there are three - Mindspace REIT, Brookfield REIT, and Embassy REIT. All three of them are listed and traded on both the BSE and the NSE.

Some of the key advantages of investing in REITs are initial investment amount of Rs 50,000, regular income as REITs generate income from rental collections and 90% of it are distributed to investors as dividends. Some of the other benefits are they are well regulated, diversify within real estate, transparency, liquidity and offers professional management. On the flipside, dividends earned from REIT companies are subjected to taxation and risk of market linked fluctuations remains. Despite the covid pandemic, REITs are emerging as a valuable proposition for all the stakeholders. However, they are suitable for investors with long-term investment horizon and seeking a professional advise before investing is crucial.

Summing up

Real estate is one of the most favoured investment choices over generations in India given its ability to generate superior returns. Apart from the commercial real estate, investors can explore new forms of investment be it in form of fractional ownership platforms or REITS. A 360-degree analysis of all the avenues and investors own risk appetite, market related factors are important before investing as the investment involves huge capital which will provide appreciation over longer term.