Upcoming areas offer higher rental yields

If an area has sound infrastructure, is well connected and is attracting high-profile tenants, you may invest in a commercial office space there

Recently, office rentals in Pune and Chennai crossed historic peak levels and Hyderabad is expected to do the same in 2018, according to property consultant JLL India. With the residential segment underperforming, high net worth investors are shifting focus to commercial office spaces, which offer the prospect of steady rental returns. 

However, investments in this space also carry several risks and should be done only after proper due diligence. But, the good news is there has been a steady rise in rentals. Commercial real estate has sound prospects at present. “Large private equity players like Blackstone, Brookfield, GIC, etc, are bullish on quality real estate in India. Net absorption in the past three years has been a steady 30-plus million sq ft, while rental rates have risen by an average of about seven per cent annually across markets over the past three years,” says Badal Yagnik, managing director, leasing services, India, Cushman & Wakefield. 

Rising vacancy levels are driving rentals up: “Due to lack of new projects in the past three-four years, Hyderabad, Bengaluru and Pune have recorded historically low vacancy rates, leading to an increase in rentals,” says Amit Oberoi, national director, knowledge systems, Colliers International India. He adds that contrary to popular belief, the information technology (IT) sector, the major contributor to demand, continued to take up the real estate space at the same pace in 2017 as earlier. According to Anuj Puri, chairman, Anarock Property Consultants, “The demand for office spaces is largely a function of the performance of the larger economy and amenable business-favouring government policies, all of which are currently in the green in India.”

Higher yield, regular returns: An investor can earn annual rental yield of 6-12 per cent from commercial property (and some capital appreciation, too), while the rental yield barely exceeds two per cent in residential property. Investors bet on residential property primarily for capital appreciation. But, with prices remaining stagnant for several years, they have been shifting to other investments. Also, grade A commercial property allows investors to deploy large amounts of capital (Rs 5 crore and above).  

The lease tenure tends to be longer in commercial properties, which translates into steady returns. “Against the customary 11 months for residential, commercial properties are leased for three to nine years, with escalation. This ensures stability of tenant, and cash flows for the owner,” says Rajmohan Krishnan, principal founder and managing director, Entrust Family Office Investment Advisors. 

Prime hubs or developing pockets?  If you invest in a prime hub such as Delhi’s Connaught Place, you could earn annual rental of only six-seven per cent. But, if you were to invest in an upcoming area of the National Capital Region (NCR), such as Sohna Road, you could earn 10-12 per cent. “An established micro market carries lower risk and, hence, offers lower return. The opposite is the case in a less established micro market,” says Yagnik. Decide which type of area you wish to invest in, based on risk appetite. The risk of investing in an upcoming area is that growth isn’t always as anticipated. The focus of development could sometimes shift to another locality. “Invest in a higher-risk market only if you are completely convinced about its prospects. New investors should stick to established micro markets,” says Yagnik. 

A major risk to investments in commercial spaces arises from economic downturns. “During a slowdown, companies may pull out of expensive office spaces and favour cheaper ones,” says Puri. 

Assess growth prospects: Before you invest, check the micro market’s growth prospects. “Proximity to infrastructure developments like a metro (rail), ring roads and corridors is a key factor. Accessibility and proximity to key locations and hubs is another positive,” says Krishnan. Next, find out how much the rental rate has appreciated over three years. A rising trajectory will give you confidence. 

If high-profile tenants are moving into the area, that is a positive sign. “Understand the marketability of your asset in case there is no current tenant or in the event the current tenant decides to move out,” says Oberoi. If the property is already leased, make sure the tenants’ lease contracts are long term. 

Compare with the rental levels in other buildings in the neighbourhood. “Suppose you are offered a property where the tenant pays Rs 100 per sq ft per month, and your yield works out to 10-11 per cent. There could be  similar quality buildings in the neighbourhood rented out at Rs 50-60. You may be tempted to invest in the former. But, when the lease resets, the rental in your building will also drop to Rs 50-60,” says Vinod Rohira, managing director and chief executive officer, commercial real estate and Reit, K Raheja Corp. He also advises investors to focus not just on the gross but on net yield. “Property taxes, maintenance charges, etc, will also take away a part of your yield,” says Rohira. 

As with all real estate investments, check the developer’s profile. Next, find out whether the land on which the building stands is leasehold or freehold. If the property is on leasehold land, you could lose ownership once the lease expires. Finally,, ensure the developer has a permit for commercial usage.