1. Residential or retail real estate: Which is a better bet for investors

Residential or retail real estate: Which is a better bet for investors

There are several benefits and challenges to investing in retail. Apart from rental yields in retail being higher than residential, owning a retail asset reduces the overall cost in case you want to start a business later.

Updated: May 4, 2017 1:22 PM
Delhi NCR tops the list of office space leasing in Jan-March quarter Apart from rental yields in retail being higher than residential, owning a retail asset reduces the overall cost in case you want to start a business later. (Reuters image for representation only)

Rami Kaushal

Traditionally, investing in real estate for an individual has meant buying a house, or residential unit. The primary reason for this is the fact that depending on the market dynamics, the capital appreciation on a residential investment is quicker. In India, individuals have always only looked at housing as a medium risk income generating asset in real estate. However, over the past few years, with the real estate market expanding and maturing, other assets like retail have started gaining prominence. While investing in either a house or a retail space provides an individual with steady rentals, returns are higher in retail. While residential yields are in the range of 1½ – 3%, the rental yields in retail are usually in the range of 6½ – 8½%.

Historically it was challenging to buy a retail space due to the lack of reliable supply and the fact that there was a lot of non-conformity to regulatory requirements in the segments. However, all of this has changed. Over the past decade, India’s retail real estate market has gone through a significant transformation. Today, retail is available across cities in 3 key formats – high street retail, community shopping centres and retail malls.

There are several benefits and challenges to investing in retail. Apart from rental yields in retail being higher than residential, owning a retail asset reduces the overall cost in case you want to start a business later. In case you do not have a retail asset and want to rent a shop, the cost of renting a store (for apparel) in ratio to the revenue is approximately 15-20%.

Few things to keep in mind when investing in a retail space are:

Prices: The cost of a retail asset will depend on the location of the retail asset. So a store in a mall or a high street may cost more than one in a community center. The micro-market would also play a role in the cost. Established or high end micro-markets could attract a higher cost than emerging or under development locations

Value appreciation: The appreciation of a retail asset will also depend on the location of the said asset. Appreciation values are better in emerging locations/under construction properties as compared to established locations. The primary reason for this is that the margin for growth is more in an emerging location. As the location develops and surrounding infrastructure gets better, the overall appeal will grow. However, on the flip side, such catchments also run the risk of not developing at the expected pace, which in turn could put your investment at risk.

Efficiency: The efficiency of a retail space (amount of usable sq.ft.) varies depending on the type of catchment. While efficiency in a high street is the highest (80%), a community centre has an efficiency of approximately 60-70% while a store in a mall has only a 50% efficiency. So in effect, a store space of 1000 sq.ft. in a mall will only have 500 sq.ft. of usable area.

One of the main challenges of investing in a retail asset as compared to a residential one is that the operational cost of owning a retail asset is much higher than a residential one. Aspects such as property tax, insurance, stamp duty and registration, water and electricity charges are much higher for retail assets than for residential. If the shop is in a mall, there is the added cost of Common Area Maintenance (CAM) which is charged by the developer. Whether your retail space is occupied or vacant, some of these base charges will still be applicable. Another challenge is finding the right tenant for your retail store. Most times this is dependent on the developer and could backfire. When looking for a tenant one should ensure that all the requisite paperwork, including leasing agreements etc. should be duly registered to avoid any additional issues. It is also advisable that when evaluating retail assets for investment, you should do the necessary due diligence around the same and not blindly accept any ‘assured return’ schemes that developers may offer.

Overall, retail is a relatively riskier asset class to invest in as it is dependent on the overall performance of the retail establishment it is a part of. However, while the risks are higher, the returns too are as high when compared to a residential asset. With RERA being implemented which includes commercial assets as well, we believe that in the long term consumer and investor confidence will grow for retail real estate.

The author is managing director, consulting and Valuation Services, CBRE South Asia Pvt. Ltd.

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