Strong upside potential, regular income flow and stability of capital values are some of the key elements that any investor would cherish in an asset class. Add to this control for making alterations and it would make a very attractive investment proposition.
While the above attributes may be matched by diligently constructing a portfolio of multiple financial instruments, a simple way to achieve the same is to make an informed investment in commercial real estate.
Commercial real estate comprises of properties which are used for a business purpose. This may include shops, restaurants, office spaces, business parks or malls. Like any other type of investing, there are multiple avenues to invest in a commercial property- one may buy a small shop in neighborhood market, housing complex or mall, a small office space or even a joint investment in a bigger office space. If chosen wisely, each of these categories have the potential to provide a relatively stable source of superior returns.
ADVANTAGES OF COMMERCIAL REAL ESTATE
High Rental Yields: the desire to earn rental income is central to real estate investing. This benefit is pronounced in case of commercial properties. As compared to an annual yield of 2%-4% in residential properties, commercial real estate in India typically yield 8%-10% or sometimes more depending on the type and location of the property. In the current interest rate environment, the strong rental yields on commercial properties provide an opportunity to earn a premium over bank FDs, bonds and other fixed income instruments*. The high yields and relatively low volatility associated with commercial real estate also make it a very suitable investment option for retirement planning.
Income Stability: another key benefit of commercial property is the long term leases. In general, the term for residential property leases varies from 1-3 years. However, in case of commercial property, the leases range from 3-9 years with a clause for increment every 3 years or so. Thus, if the vacancy risk is carefully managed, commercial real estate provides a stable source of income for investors.
Capital Appreciation: the highlight of commercial real estate investing is that it provides an opportunity to earn multiple sources of return. In addition to income from rentals, commercial property may also overtime become pricier thus providing returns through increases in capital values. In this way, an investment in commercial property yields the benefits of both equity (capital appreciation) and fixed income investing.
Taxation Benefits: the income tax act allows for a favorable treatment of returns from property investment.
Interest Benefit: section 24 allows for deduction on the interest paid on loan taken to purchase/construct/repair/reconstruction of residential or commercial property.
Standard Deduction: is allowed at the rate of 30% of annual value (annual rental income) for repairs and maintenance. This deduction in available for both a let out (rented out) commercial or residential property whether you have actually incurred any expenditures on repairs or not.
Long Term Capital Gains: Section 54F allows an investor to minimize/avoid paying long term capital gains by investing the proceeds from sale of commercial real estate into a house property under certain conditions. Alternatively, under Section 54EC, the investor also has the option to avoid paying capital gains tax by placing his capital gains in some designated government bonds up to an amount of Rs 50 Lakhs.
Investor Control/Tangible asset: a not so well understood benefit of real estate investment as opposed to financial instruments is the control that a property owner has over the investment. As a minority shareholder in a stock or bond, an investor cannot change anything the company does. However, real estate allows investors to fix up the asset, change the appearance, get better tenants, increase the rent or reduce the cost to manage the asset.
POSITIVE OUTLOOK
The economic fundamentals of Indian economy and demand supply analysis of property market suggests that commercial real estate in India is poised for attractive long term returns.
A historical comparison with economies at similar stage of economic growth (Japan post WW II, China mid 80s onwards) reveals that when a major emerging economy grows rapidly and strives to establish itself as a centre of economic activity, it creates massive demand for commercial real estate. Given India’s strong macro fundamentals, large consumer market and cost advantages, it is attracting interests from a number of global MNCs who are looking to expand their footprint in India.
The increasing interest from foreign entities along with the growth of domestic businesses is indicative of impending demand for quality commercial properties. This can be seen from a an expected ~12% y-o-y growth in absorption of office commercial (47 Mn Sq Ft) in 2018. At ~550 million sq ft, the current stock of A-grade office is almost fully absorbed and clearly inadequate to meet future demand. On the retail side, as the size of formal sector increases, there is likely to be an increasing requirement of modern retail concepts like destination malls and high street. Moreover the structural changes in Indian Realty (RERA, Demonetization) are expected to slow the pace of supply infusion. A simple demand-supply analysis of above trends implies a strong growth potential for both rental and capital values for commercial real estate in India.
Formalization of Real Estate
Over the last few years, the government has introduced a number of policy measures to help professionalize the real estate sector. Encouraged by the massive potential of real estate sector in India and favorable stance of the government, many top notch private equity and sovereign funds have been quietly accumulating large positions in commercial real estate in India. Today elite players like Blackstone, GIC, CPPIB, and Brookfield Asset Management count amongst the biggest holders of quality commercial property assets in India. (With 30 million Sq Ft of A-Grade Office, Blackstone is the leading owner of office space in India, ahead of even the largest commercial developer DLF with ~27 Sq Ft Office). Also, REITS are expected to make their debut shortly, helped largely by enabling regulation and favorable impact of demonetization.
These developments would significantly enhance transparency and governance of the property market in India. Due to RERA, REITs, Demonetization and GST, more and more commercial property assets will become institutionalized. This will result in increased credibility and valuation of the country’s real estate investment market.
CONCLUSION
One can note form the above discussion that there are several characteristics of commercial property which make it a suitable choice for medium to long term investing. Moreover, the positive outlook for Indian economy and changing dynamics of property market in India point towards an impending boom in commercial real estate. Thus, an investor will be well served to include commercial property assets as an integral part of an investment portfolio.
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