Residential vs Commercial real estate investment: Which will do better post Covid?

Investors are carefully weighing the returns from various asset classes during the current pandemic and seeking avenues to protect investments from value erosion.

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Investors are carefully weighing the returns from various asset classes during the current pandemic and seeking avenues to protect investments from value erosion. Most asset classes have underperformed in the range of -18% to -25% in recent times except gold. Real estate, which has generated approximately 7.5% returns over the last five years, has remained stagnant. However, liquidity issues and impact of the demand downturn is resulting in price corrections and changes in yields in various asset classes.

“Residential real estate (RRE) saw most impact with the prices falling across cities in India. The yields in RRE has been around 2%-4% while the pricing has moved downwards by 4.5% over the last three years,” says Ajay Sharma, Managing Director, Valuation & Advisory Services at Colliers International India.

With developers offering discounts ranging from 10-15% to push sales, returns in the short term are expected to further drop. However, “the recent government stimulus and the RBI’s push for lower interest rate regime will offset the impact on returns. The movement of demand from buying to rental due to larger macro-economic trends will push the yields higher. Further, the de-growth in the new residential supply by 25% Y-o-Y will set the price correction in the next 12-18 months, which will create positive returns in RRE,” informs Sharma.

Commercial real estate (CRE), on the other hand, has been the darling of investors, both institutional and individual investors, with the yields averaging 8.0% and the returns around 13-14% over the last three years, which also saw record absorptions across the top cities. However, with the pandemic, the increase in LRD rates, the ease and effectiveness of work from home strategies, the targeted de-densification of 20-25% by occupiers once complete lockdown is lifted are likely to dent the returns.

Occupiers are re-negotiating rentals while large occupiers are revaluating new space requirements apart from adopting consolidating strategies. The demand for Grade A commercial stock is expected to be lower, but with the supply expected to drop significantly, there could be silver lining for CRE.

Given the above observations, based on the existing trends on yields and returns, CRE would seem to be an ideal and safe investment vehicle for both institutional and individual investors. However, “the continued support package from the government through low interest rates and the extended discount from developers for the existing stock will lower the investment value barrier to most investors while the increased penetration of alternate usages like co-living and student housing formats with yields around 9.0%, increased demand for rental housing and asset appreciation (based on five year average) is expected to boost returns from RRE in the next two to three years,” says Sharma.

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