Over the years, the commercial real estate sector has witnessed tremendous growth. While some attribute this success to initiatives such as Smart Cities, others believe that the growing demand for office space in the ITeS/IT sectors has bolstered growth. According to data released by the India Brand Equity Foundation, the absorption in Grade-A office spaces will cross 700 msf by 2022. This proves that commercial property investment will be fruitful in the coming years.
Although there are umpteen reasons to invest in commercial properties, there are still some risks that need a thorough assessment. So in this blog, we will weigh down the pros and cons of this type of real estate investment and will share tips on how to avoid the common pitfalls.
What are Commercial Properties?
Immovable assets that are used for investment or rental purposes are referred to as commercial properties. In other words, they are land or buildings that are used for business and not residential purposes. This includes, but is not limited to, shopping malls, office complexes, retail outlets, hotels, and resorts. In comparison to residential spaces, commercial property investment offers high rental yield and income.
What are the Types of Commercial Properties?
Before we delve deep into the pros and cons of a commercial property investment, let us take a quick look at the types of commercial spaces.
- Office Spaces
- Industrial Units
- Shopping Complexes
- Retail Outlets
- Warehouse and Factories
- Hotels and Restaurants
- Mixed-use Lands (Residential and Commercial Spaces)
- Healthcare Infrastructure (Hospitals, Nursing Homes, Medical Centres, etc.)
Is Investing in Commercial Property a Good Idea?
Investing in residential or commercial properties can be advantageous in the long-term. While both generate steady incomes (if residential properties are rented), commercial properties provide better financial incentives. Some of the advantages of commercial property investments have been given a rundown below:
1. Stable and High Income-source
Commercial lease agreements are long-term in nature. Hence, in comparison to residential real estate, there is a regular income flow from commercial properties. Additionally, the provision of the annual increase in the agreement ensures a high and consistent return throughout the year.
2. Furnishing Expenses Less
From hotels and restaurants to banks and salons, every business wants to design and furnish their commercial units as per their needs and requirements. This allows you to offer raw and unfurnished units to tenants, thereby making your commercial property investment less heavy on the pocket. On the other hand, you have to invest a lot of money in furnishing the apartment.
3. Good Rental Yield
Getting a high rental yield is one of the biggest advantages when it comes to commercial property investments. Simply put, Rental Yield is the percentage figure of the annual earnings generated from income-generating assets. For a good commercial property, you can expect a rental yield anywhere between 6-8% of the property value. Though the total returns depend on multiple factors like the type of unit and location, the profits can be in double digits for a premium location.
4. Easy Management
Usually, big corporations or institutions like banks, retail outlets, IT companies, etc. rent office spaces. Since these entities are highly professional, it becomes easier for a commercial property owner to deal with the tenants.
5. Value Appreciation
Let’s say your commercial property is stationed in a metropolitan city. A proposal has been accepted by the government to construct a new metro line and an expressway near the property location. With excellent socio-physical infrastructure, the value of your property is bound to appreciate. Thus, commercial property investment in a premium location with new developments will be financially beneficial.
6. Net Lease Options
A commercial property owner has the option of signing a single-, double-, or triple-net lease agreement with the tenants. This offers the owner flexibility in accruing operational or maintenance costs from the tenants. Out of all types, the triple-net lease (NNN) is the most beneficial for landlords as the tenants have to pay rents and bear the majority of expenses.
Commercial Property Investment: Disadvantages
While there are many reasons to invest in commercial assets, there are some downsides associated with the same. These issues have been described below:
1. Requires Exhaustive Research
Commercial property investment yields higher returns; however, if all the factors are not taken into consideration, the investment can become a costly affair. Apart from the location and cost of acquisition, emphasis has to be laid on the taxes involved, real estate laws, building quality, demand and supply, profit opportunities, lease and deposit agreements, etc.
2. More Capital Required
Purchasing a commercial property is very heavy on the pockets. Apart from the initial capital expenditure, you also need to invest in repair and maintenance and other external expenses. However, when there is a slow down in the real estate industry in India or around the world, the investment becomes slightly affordable.
3. Expensive Loans
The interest rates on loans for commercial properties are exceedingly high. The rates are further affected by factors such as location, investor’s profile, and loan repayment tenure. Furthermore, in comparison to the house loans, the loan-to-value ratio (money borrowed against the appraised value of the commercial property) is also very low. This means that for the down payment, you have to shell out 50-60% of the property price.
4. Economic Volatility
In comparison to residential real estate, commercial properties are prone to market fluctuations. When the economy is on a spiral, it becomes difficult to lease or sell commercial properties. This was also visible during the COVID-19 pandemic when employees of companies started working from homes. The remote working model lead to a decrease in office space leasing.
5. Finding Tenants can be Difficult
Owing to the large area and high rental rates, finding tenants for commercial properties is difficult. Although the lease is signed for a long-term period, the property can remain vacant for years after a tenant leaves. Hence, it is always advised to keep some cash reserves for rainy days.
Residential vs Commercial Property Investment [Summary]
You have got an overview of the types, advantages, and disadvantages of investing in commercial spaces. Let us now weigh down the pros and cons of investing in commercial as well as residential properties.
|Residential Property Investment||Commercial Property Investment|
|Rented out to families or individuals||Rented to conglomerates and businesses|
|Rental yields not high||High rental yields|
|Lease is for a short-term||Long-term leasing possible|
|Leasing or renting process easy||Leasing process complex|
|Initial investment expenses less||Requires heavy investments|
|Affordable loans||Loans costly|
REITs: An Alternate Commercial Real Estate Investment
Companies that operate & maintain, finance, or own income-generating properties are referred to as Real Estate Investment Trusts (REITs). Not only do REITs generate a steady income, but they are highly liquid and offer a diverse portfolio. Since REITs are publicly-traded, they provide a platform for investors to enter the real estate sector legitimately. In comparison to the global real estate industry, the concept of Real Estate Investment Trust is relatively new in India. However, after the Embassy Office Parks—India’s first REIT, raised an IPO last year, these investment vehicles are gaining momentum.
7 Important Commercial Property Investment Tips
As discussed, commercial property investment requires a thorough understanding of the market and business risks. You can earn higher and steady returns on the commercial spaces only if you follow a strategic approach. We have collated 7 tips that will help you thrive in the commercial real estate industry.
Rent and asset appreciation are the two ways through which you can earn higher returns on commercial properties. It is important to note that both the metrics are heavily dependent on the location you choose. Apart from the infrastructural facilities, you should also research vacancy rates. The lower the vacancy rate, higher are the chances of finding a tenant.
To strike a healthy deal with the tenants, evaluate the neighbourhood thoroughly. Garner information on the types of commercial properties in the vicinity, their rental and occupancy rates. This will give you an outline of how much rent you can charge.
In order to retain tenants for a longer time, it is important to invest in commercial properties which have alluring exteriors and interiors, offer ample parking space, and are close to public places. Additionally, buildings which are LEED (Leadership in Energy and Environmental Design) or EDGE certified will attract more tenants and fetch higher rental rates.
Overall Rental Earnings
While understanding the market dynamic is essential, calculating the rental earnings after tax or insurance deductions is also necessary. This will give you a brief outline on what your commercial property investment holds for you in the future and whether or not you will be left with sufficient finances for rainy days.
Cross-examining a tenant’s credibility is as important as evaluating a building’s quality. Reputed organizations or corporations handle business professionally. Hence, you will not have to run from pillar to post for rent. However, for lesser-known tenants, it is wise to check their credibility. One way of doing this could be through security deposits. The tenants are required to submit 10-12 months of property rents as security deposits. If the tenant insists on paying for only 6-7 months in advance, then this can be an indication of cash flow issues.
Before acquiring a commercial property, it is recommended to take assistance from professionals such as lawyers, chartered accountants, tax experts, and real estate consultants. It will help you understand various facets of different laws and legislations.
Background Check of Agent
Another important commercial property investment tip is to conduct a background check on the real estate agent you wish to work with. Go through past rental agreements, check for legal offenses, verify the license details, etc.
Whether it’s a residential or commercial asset, the investment process can be slightly confusing. Apart from understanding the market dynamics, you also need to have a thorough understanding of the taxation and other laws pertaining to the sector. But with the aforementioned tips and a proper plan, you can mitigate the risks associated with commercial property investment!