Investing in commercial real estate: Pros and cons, tax implications explained

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Updated: November 12, 2021 5:05 PM

CRE properties are valued at 25-30 crore and upwards. Traditionally, CRE investment has remained restricted to UHNIs and HNIs owing to the exorbitant ticket size.

commercial real estate investmentRepresentative image

With products like fractional ownership and REITs, investing in Commercial Real Estate (CRE) properties has become budget-friendly and less tedious. CRE can provide a steady cash flow in the form of rentals. However, experts advise that investors should first carefully scrutinize their financial health, investment goals, risk-bearing capacity and the timeline for generating profits.

CRE properties are valued at 25-30 crore and upwards. Traditionally, CRE investment has remained restricted to UHNIs and HNIs owing to the exorbitant ticket size. However, with new business models such as fractional ownership and REITs, CRE as an asset class has been largely democratized. While the average minimum amount of capital required to invest in residential property ranges anywhere between Rs. 50-70 lakh and the amount may vary depending upon the location of the property, fractional ownership allows owners to own a part of commercial property with a ticket size as low as 25 lakhs.

So, is CRE a better investment than residential property? According to Sudarshan Lodha, CEO and Co-Founder Strata, there is no simple one-word answer for this. “While it is true that profitability is much higher in commercial real estate, entering the CRE market as an individual investor is tough. Legal complications, domain knowledge, financial components are various hurdles that come in the way of retail investors. However, now they can be solved by opting for REITs or fractional ownership,” Lodha told FE Online.

“Having witnessed the rising demand for commercial real estate and positive future graph I would advise investors who are eyeing a second residential home from an investment perspective should in lieu consider investing into commercial real estate which will offer far better returns. Also, the main reason for preferring commercial real estate over residential counterparts is the higher rental value. Commercial real estate offers up to 3 times the returns to that of residential properties,” he added.

Average returns in last 5 years

Rental returns in the case of residential property is around 1-2% while in CRE it is 8-12%. The returns in real estate have been consistent over the last decade and may continue to perform similarly in the next few years.

“Rental returns in case of RRE is around 1-2% while in CRE it is 8-12%. With rising demand for commercial spaces, the demand for CREs is expected to pick up momentum in Tier-II cities as well,” said Lodha.

Pros and cons of investing in commercial real estate

CRE includes a wide variety of potential assets such as warehouses, manufacturing units, retail spaces, parking lots, schools, malls and movie theatres to name a few. According to Lodha, below are some pros and cons of investing in CRE

Pros

Stable source of high rental income: The average rental income of the residential real estate is 1-2% while that of commercial real estate reaches a staggering high of 8-12% thus offering 3 times higher yield.

Professionalism: The tenants in CRE have generally established businesses and therefore one can be assured of professional behaviour.

Long-term commitments: The leasing tenure of commercial tenants is usually more ranging anywhere between 10-20 years which provides investors with a secured and stable source of income on their investment.

Appreciation Value: Commercial real estate provides excellent appreciation over a longer period as compared to other property types. Also, investing in a premium commercial property through REITs or fractional ownership may provide attractive returns with much lower and pocket-friendly investment.

Cons

High Ticket Size: Valued at 25-30 crore and upwards, the minimum investment required in CRE is typically exorbitantly high and therefore beyond the reach of a retail investor.

Asset management: Investing is not just about parking your money in a particular asset or owning it but also ensuring smooth end-to-end asset management which includes the tenants. In the case of CRE, tenants are corporates and not individuals which makes asset management more complex as retail investors usually lack the professional expertise for managing commercial assets.

Difficult entry: Investing in CRE can be challenging for a naive lone investor owing to the complex legalities and limited market opportunities.

Choosing appropriate property: Choosing the right property and geographical location requires extensive research and market knowledge. A retail investor may therefore find it extremely challenging to invest in CRE owing to a lack of adequate expertise and market knowledge

Tax implications

Usually in commercial real estate, for investors as per the current income tax regulations, rents received from the property are taxed under “income from other sources” under the applicable tax slab.

“Despite gaining popularity among its investors, fractional ownership of commercial real estate is still at a nascent stage, therefore there is no established tax regulation for this asset class,” said Lodha.

House property taken on a home loan, qualifies for tax breaks under Section 24 and Section 80C of the Income-Tax Act. NRIs can explore the benefits under the Double Taxation Avoidance Agreement (“DTAA”) entered with the respective country, subject to availability of Tax residency Certificate (“TRC”).

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