Commercial real estate is doing well but assess the risks before investing in it
Experts do not advise retail investment in physical commercial real estate—shop, office or land
Recently, finance minister Nirmala Sitharaman said in a conference that several important indicators have emerged in the recent past pointing towards green shoots in the economy. She talked about seven such indicators, one of which was the fund flow coming from outside the country. The minister said that global sentiment was in favour of India and the country received foreign direct investments (FDI) of $24.4 billion from April to November 2019 compared to $21.2 billion in the corresponding period of the previous year. According to various estimates, commercial real estate attracted a significant portion of the total FDI. “The year 2019 concluded with private equity (PE) investment volumes being recorded at healthy levels of ₹43,704 crore ($6.2 billion) in real estate, a 3% year-on-year increase. Foreign investors made up a significant share (72.9%) of the overall investment inflows during 2019," according to data compiled by Cushman & Wakefield India, a real estate consultancy.
Though inflows to the commercial real estate sector remain strong, the residential segment is not as popular as it was a decade ago with investors, developers and financiers alike. A decade ago, demand for the residential segment was high, which has waned now with the market facing various challenges, including stalled project and delays. Most buyers are now sceptical of investing in residential real estate for returns and are only looking at buying for end-use, which is what experts suggest as well. Those interested in investing in the real estate sector are more optimistic about the commercial segment instead. But does it make sense for retail investors to buy commercial property? Read on to find out.
Despite the slowdown in the country, various reports indicate continuous improvement in commercial real estate—be it supply, absorption or increase in rentals and capital values. But mostly the demand is not from domestic companies. “Commercial real estate in India is driven by demand from large multinational corporations who have set up development centres, back office operations and research facilities in cities like Bengaluru, Hyderabad, Pune and Gurugram. Steady demand for large office spaces from these tenants has led to significant growth in office supply and stock in these cities," said Kunal Moktan, chief executive officer and co-founder, PropShare Capital, a tech based commercial real estate investment platform.
Multinationals occupying office space in India for their back-end work is the reason commercial real estate is doing well despite the slowdown, said experts. “A slowdown in the Indian economy is not correlated to office demand as most of the tenants are international companies who do not earn revenues from India. Today, tenants like CISCO, Goldman Sachs, JP Morgan, Merrill Lynch, Amazon and GE have their largest offices outside of their home countries in Indian cities," added Moktan.
Anshuman Magazine, chairman and CEO (India, South East Asia, Middle East and Africa) of CBRE, a real estate consultancy firm, agreed. “The demand was largely driven by tech corporates, with multinationals accounting for more than 70% of the overall space take-up by these firms," he said.
There are different types of commercial properties you can invest in—a small shop in a neighbourhood housing complex or a mall, or a small office space, or even a joint investment in a bigger office space. Each of these should be looked at from different perspectives—the investment amount, tenant profile, returns, exit options and the associated risk.
However, right now, the supply of office spaces is higher as they are in demand. Within this, Grade A or premium office spaces comprise the chunk of the supply. Grade A properties are those that are located in central business districts and are also well-managed.
For investing in such commercial spaces, an investor needs to have deep pockets. “Commercial real estate has been a very difficult asset class to invest for retail investors by virtue of their large ticket sizes, sophisticated understanding of lease structures and the need for active asset management. Ticket sizes range from ₹20 crore-100 crore for Grade A assets with multinational tenants, which is usually beyond what ordinary investors can afford," said Moktan.
What should you do?
Experts do not advise retail investment in physical commercial real estate—shop, office or land—because it requires high ticket sizes as well as proper due diligence in terms of legal and future market outlook which may be difficult for you to manage. Also, maintenance of such properties is a tough task. At the same time, physical real estate is an illiquid asset—there may not be enough demand for the asset when you need to sell it. It also involves dealing with practical issues like transacting with agents and lawyers, besides paying high transaction costs such as brokerage, stamp duty and legal fees.
“As a concept, investing in commercial real estate is a better idea, but it’s a very risky asset. For instance, there are very few malls which are running successfully; in fact, most of them are struggling. Maintenance of commercial real estate like managing the tenants, collecting rent, paying property tax on time and so on, is also cumbersome," said Rohit Shah, founder and chief executive officer, Getting You Rich, a financial planning firm.
But if you still want to invest in commercial real estate to diversify your portfolio, first assess your risk appetite, investment horizon and the purpose of investment (rental return, long-term investment and diversification).
One way to reduce the risks is investing in real estate investment trusts (REITs) instead of physical assets. Though these instruments come with their own risks, they help you address the challenge of dealing with large ticket sizes and are transparent. The first REIT was launched in India in 2019 and more developers are now planning to come up with REITs. “India’s first listed REIT, Embassy Office Parks’ REIT, was successful in the commercial office sector and reported a 15% increase in revenue from operations for the quarter ended September 2019 over the previous quarter. This positive result has persuaded other leading developers to consider expanding their portfolios and thereby attract many institutional investors from across the globe," said Shishir Baijal, chairman and managing director, Knight Frank India, a real estate consultant.
REIT may be a new investment avenue in India, but it has been around globally for more than five decades. According to a recent report by Axis Securities Ltd, “REITs across the globe have performed at comparable levels to broad equity indices. For example, REITs have averaged 11.1%, while S&P 500 has averaged 9.8% over the last 28 years. They have shown low volatility and recession protection similar to defensive equity stocks. REITs have also shown lower correlation with other asset classes like equity, debt and commodities. Thus, they provide an excellent option for diversification."
Moreover, according to experts, in times of economic slowdown, it is better to invest in them. “REITs provide downside protection during economic downturns as the underlying cash flow is contractually bound by long-term leases thereby ensuring a steady dividend yield at all times," stated the Axis report. “REITs are a promising option, but as of now there is only one REIT available in India so it makes sense to wait for some time until there are more options in the market," said Shah. There are various REITs lined up to get listed, but do check the underlying assets, developers’ track record and past performance before investing.