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Business News/ Opinion / Nuances of commercial realty

Nuances of commercial realty

What an investor should look for when she scans the commercial real estate market for investment

Shyamal Banerjee/MintPremium
Shyamal Banerjee/Mint

While you would have tick-marked several checklists while investing in residential properties, parking your money in a commercial real estate project could be a different ball game altogether. A detailed comparison between the two shows a world of difference in the underlying nature of these assets, purpose of investment, lease tenors, terms and conditions involved and, most critically, the need for larger quantum of funds and a wider investment horizon. What then should an investor look for when she scans the commercial real estate market for investment?

Where should you park your money?

While parking your money in commercial properties, you can either choose to partner with a developer to build one or invest in a completed project and subsequently lease it out. You can also choose to invest via indirect modes such as real estate investment trusts (Reits), private equity funds or venture capital financing. It is also essential to note that commercial real estate typically requires larger ticket investments as compared to residential property. You also need to work out the cost-benefit trade-off, between the potential rental income and the various overheads in the form of maintenance expenses, taxes, insurance premiums, and so on.

Place and time is critical

The location you choose is most crucial. It is preferable to invest in a city’s prime locations, around its Central Business District. However, high prices are moving demand for office space towards peripheral areas. Hence, if you choose a suburb, you must also take note of the availability of transport and social infrastructure. Investing in mixed-use (integrated residential and commercial real estate complexes) may fetch better rental yields.

Alternatively, you could opt for smaller properties while investing in prime locations. The performance of local industries determine how lucrative your investment will be in the long run. While Bangalore and Pune are perceived to be information technology hubs, Chennai is emerging as a major nucleus for automobile companies. Mumbai, needless to say, is the country’s financial capital and banks as such contribute majorly to office space demand. The prevalent occupancy rates in a particular micro-market will also reveal a lot about the demand potential. Investing in areas with high occupancies will make it easier to find tenants and also boost rental income.

Inking the deal: Choose your tenants carefully

High commercial real estate prices have led to an increasing preference for lease, rather than an outright purchase. However, while leasing out commercial properties, you would need to understand a whole new gamut of terms and conditions—tenors, occupancy/vacancy levels and other terms of the agreement, before you give your property on lease.

Commercial real estate deals, typically, have a lock-in period of three years. You also need to be aware of the fact that exiting from a commercial property deal is a greater challenge, compared to a residential property as lease tenors are relatively longer. This highlights the need to have an exit clause included in the agreement, which clarifies the conditions under which an investor can exit the deal in case the situation demands.

Occupancy levels play an important role in deciding the rentals for commercial properties. Shorter agreements entail frequent tenant changes and sometimes even lead to prolonged vacancies, which could dent your returns. A macroeconomic slowdown and a muted business outlook significantly impact demand for leased commercial properties, with a commensurate effect on rental income.

Diverse client base can ensure stable rental income

A balanced approach here is essential. A way to tackle fluctuation in occupancy levels is to invest in smaller commercial properties. This is a valid approach if you want to invest in a prime location but are unable to find a big client. Smaller multiple investments rather than a single big ticket investment can help diversify your client base and ensure steady stream of revenue.

Smaller office spaces are apt for professionals as they prefer to set up offices across multiple locations in a region. For instance, leasing out commercial properties to professionals such as doctors and lawyers can be a safer bet as the underlying demand for services of such individuals would drive footfalls and accordingly, boost incomes for both the tenant and the owner (you).

Thus, choosing the right location, understanding the demand scenario and being familiar with terms of the lease may help an investor choose the right commercial property and lease it out to the appropriate client.

Binaifer Jehani, director, Crisil Research.

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Published: 04 Aug 2014, 08:02 PM IST
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