Bet big on office space
With demand inching up, investors can find good deals in commercial property
Apr 07, 2014
Source : The Hindu

 

MUMBAI: Thinking of buying your third apartment at Worli? Why not an office block in BKC instead? It may not have quite the charm or glamour of a penthouse apartment, but it can certainly get you hefty returns.

If you are looking to park large sums over a longer period of time, this is a good time to look at commercial spaces, which are up for grabs in most markets. After the 2008 financial crisis, prices in markets such as Mumbai nosedived 30 per cent. Now, with demand inching up and the economy reviving, investors can find good deals in the commercial space.

Why the buzz?

After a prolonged lull, prices may have bottomed out in most markets and buyers are seeing value, say market observers.

“Private bankers and wealth management firms confirm that their clients have actively started investing in commercial properties after staying away in 2009 and 2010,” says Ramesh Nair, COO - Business, Jones Lang LaSalle India. Among the ultra HNIs surveyed, 65 per cent wanted to increase their investments in the commercial space, says a report by Knight Frank, a real estate advisory.

 

While prices may not appreciate immediately, demand may pick up in the next few years, as the economy expands. Supply is also waning since many developers have converted planned commercial spaces into residential projects. The sector may also get a leg-up when the proposed Real Estate Investment Trusts (REITs) that own and operate income producing property, become a reality.

It’s also a given that rental income from commercial properties is much higher than the paltry amounts residential spaces fetch. You can expect a handsome 8-10 per cent rent on your commercial property investment compared to 2-5 per cent on residential purchases.

So now that you have decided to buy a commercial property, which one do you go for? When investing in commercial real estate, you have broadly three options — office spaces, retail outlets and warehouses.

Multiple options

Right now, given the growing demand, office space may be a safer bet. Demand is expected to scale up substantially, with 200 million sq ft (msf) of office space likely to be added in the next five years. This is a near-50 per cent addition to the estimated 375 msf in use, according to a data from Jones Lang LaSalle, a real estate advisory.

Maintenance is also relatively easier when it comes to office property, and the quality of tenants is superior as well. Also, unlike in the past, where buying multi-tenant building was the only option, you can now buy smaller office spaces within the same complex. This offers much more flexibility.

Also, buildings are now specifically designed to suit the needs of a particular sector such as IT. With the entry of new players into the banking space, buying smaller standalone offices that cater to banks can also be a lucrative choice.

Other options in the commercial property space like buying retail property or shops in prime locations may also be an attractive long-term investment option. But mushrooming malls are taking the sheen away from high-street rentals, cautions Amit Bhagat, MD and CEO of ASK Property Investment Advisors. Unlike office property, tenant churns can also be high in such retail properties and, hence, vacancies can hurt your returns.

Warehouse is another option that saw traction in manufacturing belts such as Chennai and Pune. Investments are small, as there is minimal construction involved. All you need is sufficient land close to the highway. While such investments can yield high returns, there are very few pre-leased options, notes Anshuman Magazine, CBRE, a real estate advisory firm.

It can also be difficult to find a client and handle the day-to-day operations. Investing in service apartments is yet another option, but is still limited to institutions. It is yet to gain ground among individual investors in a big way owing to larger investments and operational issues.

Take stock of risks too

While investment in commercial properties can yield a good rental income and also appreciate substantially over a period of time, you need to weigh the risks too. When it comes to investing in commercial real estate, there are broadly two risks.

One, exiting the investment may not be as easy as in the case of residential properties. You may not find a buyer when you want to sell the property cautions Shobhit Maleta - Director, Portfolio Advisory Services at Knight Frank India.

There is the tax aspect too. When you sell commercial property, you have to invest the proceeds only in a residential property to avail of long-term capital gains exemption, notes Rakesh Nangia, Managing Partner at Nangia and Co, a tax consultant.

Two, given the size of the investment, you may also be prone to concentration risk, when investing in a single location. The risks can be particularly high in smaller markets such as tier-2 cities where demand-supply dynamics may turn volatile.

Both these risks are somewhat lessened when you own smaller units. However, quality tenants such as banks and multi-national corporations do not opt for spaces that are smaller than 5,000-10,000 sq ft.

Thus, you are forced to invest upwards of ?5 crore in a single property, notes Maleta. He advises though, that you avoid buying property costing over ?25 crore as a single unit, as this will reduce your pool of prospective buyers, and make it tougher to exit the investment.

One other way to reduce risk is to invest in real estate private equity funds. These are registered by SEBI under the Alternative Investment Funds Regulation (AIF) and require a minimum commitment of ?1 crore. The fund invests the pooled amount in multiple properties and locations.

This way of indirectly holding properties through the PE route can enable investors to put in smaller amounts and mitigate some risks.

However, exits are an issue for PE funds as well and may continue to be a challenge until REITs take off in a big way.

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