Office space demand can translate into high returns, say experts

Oversupply and poor maintenance can, however, affect investments

Companies are insisting that employees return to the office. Businesses that gave up space during the pandemic are looking to re-lease it. As a result, the prospects of commercial real estate (CRE), which had nosedived during the pandemic, have brightened.
 

Robust demand
According to data from CBRE, in the past nine months, India’s office sector absorbed 42.1 million square feet (sq. ft.), registering a growth of 66 per cent year-on-year (YoY).

Supply grew slower, at 4 per cent YoY to 35.6 million sq. ft. “Calendar year 2022 could turn out to be one of the best for office leasing in India,” says Anshuman Magazine, chairman and chief executive officer (CEO)-India, South-East Asia, Middle East & Africa, CBRE.

International businesses are expanding in India: the result of multinational companies (MNCs) pursuing a China-plus-one strategy. “When MNCs set up their manufacturing base in India, their research and development centres, design centres, and other back-office functions also shift to this country, augmenting the demand for office space,” says Saurabh Shatdal, managing director, land and capital markets, Cushman and Wakefield India.

He adds that many MNCs, which were planning to set up their offshoring centres in eastern Europe, have now decided to set them up in India owing to the Russia-Ukraine war.

Disappointed with the returns from the residential segment, many high-net-worth individuals (HNIs) have shifted focus to CRE. “Besides offering low capital gains in the recent past, even rental returns from residential real estate are poor at 3-4 per cent, whereas in CRE investors can earn 6-8 per cent,” says Subhankar Mitra, managing director, advisory services, Colliers India.

Attractive, stable returns

Besides rental returns, investors can enjoy capital appreciation by investing in a quality building from a reputed developer at a well-chosen location.

CRE is also a relatively stable asset class. “Investors can earn a regular income while maintaining a low-risk investment profile,” says Bappaditya Basu, chief business officer, Anarock Commercial.

The successful launch of three real estate investment trusts (REITs) has added to the attractiveness of CRE by providing investors with an additional exit option. CRE, however, has a high entry barrier. “A commercial space in a Grade B development may cost between Rs 40 lakh and 80 lakh,” says Basu. Mitra says that many developers in Grade B buildings do strata sale, with sizes ranging from 500 to 5,000 square feet, which an investor could buy for Rs 1.5 crore to 5 crore.

Investment in a Grade A building requires a larger budget.
 

Demand, supply

If for some reason — an economic downturn or a pandemic — the demand for CRE slackens, it could lead to vacancy.

Another risk could come from oversupply. “Investors’ returns could get affected in markets where a huge amount of supply is set to come up in the near future,” says Shatdal. Degradation of the quality of the building or the neighbourhood could also affect returns.

“Operation and maintenance directly impact rental value, which in turn impacts the potential yield from investments,’’ says Magazine. The entry price, too, has an impact on returns. “Paying more than the market value, and investing in a commercial space in a building that does not have all the right regulatory approvals, are key risks,” says Basu.
 

What should investors do

According to Basu, seeking out the cheapest commercial properties to invest in is usually a recipe for failure. Investors need to take a long-term view, especially if they have invested in an upcoming area.  
 

“In such locations, demand could be low today but the area may come into the limelight a few years down the line, with the completion of new infrastructure or the moving in of large domestic and international companies,” adds Basu.
 

Investors must do research on their chosen micro-market to understand the floor size that is likely to attract the right tenants there. 
 

According to Mitra, investors must also examine the arrangement that is in place for maintaining the building as this will have a major impact on returns over the longer term.
 

Investors who need  to opt for REITs

• Through REITs, investors get access to high-quality, diversified portfolio of commercial real estate
• Low-entry barrier as investors can purchase even a single unit of a listed REIT
• Around Rs 10,000-15,000 is required to participate in a REIT initial public offer
• This is a liquid asset since REIT units can be easily sold on exchanges; selling real estate is much harder
• Negative developments in the underlying asset (say, declining rental demand) could cause volatility in the price of REITs