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Commercial property: Opening up to retail investors

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India’s collective office space stock accounts for only 375 million square feet. India’s collective office space stock accounts for only 375 million square feet.
SummaryMany retail investors are now getting into the office real estate game.

Buying an office or retail space is a huge investment, which is why commercial realty has been traditionally seen as an asset class that only institutional investors or high net worth individuals could invest in. That, however, is changing. Many retail investors are now getting into the office real estate game.

For a perspective of the opportunities in Indian commercial real estate, consider this – Manhattan in New York has 450 million square feet of Grade A stock, while London has 200 million square feet. In comparison, India’s collective office space stock accounts for only 375 million square feet. This showcases the long-term potential for office space at all levels in India. The next few years will see a spurt in the services and knowledge sector, opening up opportunities for the retail investor.

INVESTMENT ROUTES

There are three ways to invest in commercial real estate: directly buy office space from a developer, buy stocks of a developer in the commercial realty space, or invest in a real estate fund focused on commercial real estate.

As the quantum of investment is usually huge, the buyer needs to take informed decisions. Another option, real estate investment trusts (REITs), is expected to be opened up shortly by the government. REITs are pooled investment entities where the corpus is invested primarily in completed, income -yielding real estate assets and distribute a major part of the income generated among their investors.

Many developers, especially in cities such as Mumbai, are today offering smaller units (as small as 500-1,000 square feet) in Grade A buildings given the higher vacancy and pressure on pricing. This is in sharp contrast to the scenario a few years ago, where only larger units were available – making it tough for a small investor. Investors considering retail space can now look at a multitude of affordable options in free-standing high street outlets or shops in malls. The advantages of smaller units are two-fold: it is easier to find tenants, and the premises can also be used by their owners. Today, professionals like doctors, auditors, stock brokers and lawyers are buying commercial properties for investment and self-use. Banks are willing to lend up to 50-60 per cent of the loan to value for this segment.

The investor should focus on a few carefully selected markets with a diverse economic base and a deep pool of tenants. While looking at under construction projects, the investor should look at developers who have a track record of delivering high quality projects on schedule.

WHAT TO LOOK FOR

Despite the availability of more rationally priced options, investing in commercial realty is most definitely not child’s play. It requires forethought, research and planning:

* Investors need to establish the soundness of the location and its demand/supply dynamics. Otherwise, they may end up buying into micro markets which have or will have high vacancies.

* They need to factor in the economy, job market, future infrastructure development and population growth in the market.

* They need to check developer credentials, access to public transport and quality of property management.

* They need the services of a knowledgeable real estate agent and a lawyer.

* If they are investing in a retail store, they need to consider the frontage, foot-fall and the dynamics of the adjoining catchment.

For an income producing office asset, one should look at:

* The break-up of cash flows, and the vacancy factor.

* Expenses such as maintenance, property tax and building insurance.

* Lease term, lock-in period and expiry dates.

* Long term capital appreciation, refurbishment, and repositioning potential.

LOOKING AT YIELDS

The rental yield for commercial property is usually 9-11 per cent. In contrast, the yield for residential property is much lower at 2-3.5 per cent. The demand for office space in India is likely to stand at around 200 million square feet over the next five years. Post the global financial crisis, prices in markets like Mumbai have dropped around 35-40 per per cent and have bottomed out in most micro-markets, offering investors a good opportunity.

Remember, you do not only make a profit on the sale of appreciated commercial property – the rental cash flows of a well-located office or shop space are considerable. Unlike in residential property, the income that can be generated from commercial property is what determines its value.

The author is COO – Business, Jones Lang LaSalle India

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