With strong rental yields, capital appreciation, and tax benefits, CRE offers the potential for steady returns and portfolio diversification.
While residential real estate and traditional investment options such as gold, fixed deposits, and the stock market have long been favoured by investors, commercial real estate has recently piqued the interest of many. Here’s why.
One of the main reasons why Indian investors are keen on commercial real estate (CRE) is the fact that, “India is integral to corporate office occupiers” portfolios, and many international players are expected to continue to expand in India. Factors like upbeat leasing, robust outsourcing activity, growth of several micro-markets, and continued expansionary leasing by GCCs and domestic occupiers have boosted investors interest in the office segment, thus making it a lucrative investment proposition for short, medium, and long-term gains. Retail and logistics assets have also seen good traction recently.
COMMERCIAL REAL ESTATE ROI
The ROI in CRE can be substantial, making it an attractive option for secondary investment. For instance, let’s consider a commercial property purchased for Rs five crore with an annual rental income of Rs 50 lakh. Assuming that the property appreciates by four percent annually, the ROI after one year could look something like this:
Rental income: Rs 50 lakh
Property appreciation: Rs 20 lakh (four percent of Rs five crore)
Total return: Rs 70 lakh
ROI: (Rs 70 lakh / Rs five crore) 100 = 14 Percent
This example illustrates how CRE can deliver a strong ROI, combining both steady rental income and property value appreciation.
Ways to earn a good return on investment (ROI) through CRE
1 Rental income : “CRE often provides a steady income stream via leasing. The potential rental yields are significantly higher than those from residential properties, typically ranging between seven to 15 percent depending on the property type and location.
2 Capital appreciation : Over time, commercial properties appreciate due to market demand, improvements to the property, or developments in the surrounding area. This alone can ensure a significant capital gain based on the number of years you hold the property investment.
3 Tax benefits : Investors can benefit from various tax deductions related to property depreciation, mortgage interest, and other expenses, enhancing overall returns.
4 Debt equity ratio : ROI on CRE is significantly influenced by the debt-equity ratio. Ideally, a 100 percent equity investment allows for ROI calculations from day one since all income directly contributes to returns. However, if debt is involved, the cost of interest reduces net income, impacting the overall ROI until the debt is repaid.
Benefits of CRE as a secondary investment
“CRE typically offers higher returns, often between eight and 12 percent annually, making it more lucrative compared to other real estate investments. Additionally, CRE serves as a powerful diversification tool, reducing an investor’s risk and exposure to market fluctuations by incorporating a mix of property types like office buildings, retail spaces, and warehouses. Furthermore, CRE acts as an effective inflation hedge, as lease agreements often include rent escalation clauses tied to inflation, protecting the investor’s income from eroding purchasing power”.
“First, it diversifies portfolios, reducing exposure to stocks and bonds and spreading risk CRE provides steady income through rental income, primarily from long-term mortgages, providing a reliable source of income. Meanwhile, the potential for property appreciation, especially in high-demand areas, increases capital gains. Lastly, the use of cash to manage large assets and the inflationary nature of CRE keep returns high, making it a stable and profitable investment.”
How to go about it?
Irrespective of whether you are a seasoned or a novice investor, due diligence is the key to a successful investment. Understand the market dynamics, especially the local market of the area you are planning to invest in. Aspects such as the demand, economic conditions, and growth potential are all important. “Start with assets that are ready for occupancy. Factors such as the quality, compliance, and legality of an asset can significantly influence its yield potential, so it’s crucial to consider these aspects. Additionally, assessing the credibility of the developer, and reviewing their historical performance are all essential steps. The corpus of investment depends on the location and the investor’s risk appetite; however, even for a retail investor the entry point is quite low thanks to Real Estate Investment Trusts (REITs). There are a few risks that one should keep in mind. Operational and maintenance factors directly impact the rental value, impacting the potential yield from investments. Hence, the property’s upkeep is fundamental. Since leases for CRE usually last for a longer tenure, finding the right tenant for the property may be challenging. Real estate market knowledge and a longer investment horizon are a necessity to invest in CRE.”
It’s crucial to thoroughly understand the terms of lease agreements, especially the lease duration and rent escalation clauses. Proper financial planning is essential, as you’ll need to account for loan repayment (if any), maintenance costs, property taxes, and other expenses.
“Consider whether to manage the property yourself or hire a management company, as effective management can significantly impact ROI. Ensure the investments align with your financial goals and risk tolerance. Be aware of zoning laws, tenant rights, and other legal factors that can affect property management and profitability. Recognise that CRE investments typically require a longer time horizon to realise significant returns, making patience essential for success.”
Even though you are prepared, there is always a chance of things going south in any investment. Thus, ensure legal compliance and prepare an exit strategy, factoring in market conditions.
