Most of us think that commercial investment is an asset class for big investors or for those owning huge ancestral properties. Let’s find out if commercial real estate is meant for your golden basket of assets or not. I have received various queries from many of my clients to understand whether they can think of investing into commercial real estate or would it not be a wise decision? There cannot be one single yes or a no for each query I get because there are multiple factors involved which are variable to each client. Many investors complain that they invested in so and so asset but they are not happy with the returns, in fact they consider selling off their asset at a loss. This article will prove insightful for them as well because they will now understand those important factors to be evaluated before selecting any asset class.
Also the current pandemic has shown sudden shift in earnings. Many employees have faced salary cuts and many have faced zero cash inflows in their businesses. During such tough situations, having a second source of parallel income is a boon. Better late than never, let’s understand why you should consider owning a commercial real estate and how it can bring you great returns.
What is Commercial Real Estate?
Commercial Real Estate includes office, industrial, multifamily, and retail. Commercial real estate provides income, as well as some capital appreciation, for investors. So any property class performing an income generating operations within its premises comes under commercial real estate category.
Edge of Commercial Real Estate – Why is it better than other asset classes?
Higher Appreciation: Historical Data has proved that commercial real estate has witnessed higher appreciation in long run as compared to other investment classes. This is especially true if you choose the right structure and location for your property.
Extended Lease: Commercial Real Estate enjoys longer lease terms as compared to residential real estate. Therefore investing in commercial real estate provides long term returns to the investors with leasing being signed for several years.
Reduced Risks: Although there are multiple options available in the market to put your money in, yet if your investment decision is directly proportionate to the risk involved than commercial real estate is less risky in comparison to other options which can prove to be very risky if failed. In commercial real estate if the tenant or the business operating in your property fails, yet you can be assured that your asset will yield you higher returns provided the property is located at a prime location. Secondly, with long leasing terms, you get a regular income in terms of rent even when the economy is unstable due to legal viability of the leasing agreement.
Steady Cash Flows: One of the advantages of commercial real estate is regular flow of rental income due to long leasing period. Also inflow of income is not related to sale of property unlike stocks that only bring profits when purchased or sold. A regular rental income can be generated by investing in commercial real estate with strong leasing terms.
Proprietorship Title: Owning a Commercial Real estate is a matter of pride and achievement. When you own a commercial real estate, it gives a feeling of fulfillment and financial security as well which is not associated with ownership of other asset classes like stocks.
Promising Returns: Based on July 2018 data from National Council of Real Estate Investment Fiduciaries (NCREIF), private market commercial real estate returned an average of 9.85% over the past five years. This credible performance was achieved, together with low volatility relative to equities and bonds, for highly competitive risk-adjustment returns.
Higher Rental Yield: The rental yield from real estate is much higher than returns on any traditional sources of investment. Commercial investment can yield upto 12% ROI and lowest to 5% ROI (with capital appreciation) depending upon the construction stage and lease terms of the property. Read about ROI and Capital Appreciation on commercial real estate.
Hedge against Inflation: An increase in the prices of goods and services increases profits which in turn increases possibility of higher rents. Economic growth benefits commercial real estate investors as they can raise the rent, giving them hedge against inflation in commercial real estate sector.
Narrow competition: The competition is comparatively less in commercial real estate market than residential real estate. Offsetting the asset becomes easy due to fewer options available in the market to compete with your property. Hence it gives an easy exit to the investors when they wish to sell off their property with good returns.
Factors to be considered while searching Commercial Real Estate
Brand: First and foremost consideration while selecting your Commercial Real Estate Asset Class is Builder Background. Never fall for a low category brand due to cheap rates. A commercial property can give you better returns if the Builder has strong leasing potential and has successfully delivered and leased commercial projects in past. Also check whether the project is RERA certified or not. Investing in an under construction project not having RERA number can lead your investment in a pitfall.
Location: Location, Location and Location. No matter how normal or usual it sounds, location continues to be the most important factor while zero downing your decision on selecting commercial real estate. Location has two primary considerations to narrow down your search. If an existing micro market is beginning to show saturation, an ‘emerging’ corridor can very well be evaluated provided the infrastructure and other parameters support. This not only enables a good buy but can also assure capital appreciation in the long term. two aspects of location are as below: –
- Infrastructure: When deciding among various available options to invest, you need to take clarity that whether the property has proximity to city’s central business hub, infrastructure developments of the location, availability of transportation etc.
- Habitation: It is important to evaluate the surroundings of your property. Volume of habitation, their household income and their spending patterns is important consideration. You also need to check if there is another alternative point of purchase available in that area or not etc.
Stage of construction: It is always advisable to invest in a commercial real estate when the project is at its initial stage of construction or launch stage. This gives you benefit of earning higher returns of your investment.
Quality of Construction & Future Marketability: While evaluating Commercial Real Estate options, you need to spend certain time in understanding the construction quality of the project in terms of construction technology, safety measures, quality certifications and future readiness of the property. By future marketability of the property I mean whether the amenities planned within the project are good enough to cater future requirements of tenants or not. Like number of parking slots, waiting time for lifts, recreational activity area, food courts, retail etc. These amenities may vary depending upon whether you are investing in a retail shop or an office space. Bottom-line is to evaluate the building based on your tenant’s requirements. Better the facilities, higher the rent you can charge.
Documentation: Needless to say that checking the necessary documents before initiating any transaction to buy either commercial or residential real estate in very important. Check the RERA number for an under construction project. RERA number itself is a confirmation that the project has all the legal licensing in place. If you are buying something in resale transaction, do check papers for title of the property, property tax papers, unpaid utility bills and any other outstanding prevailing to the property. If the property is tenanted, a thorough understanding of the contract, especially lessor’s covenants /obligations should be undertaken. This would ensure there are no surprises in the future. It would be absolutely mandatory to check the presence of mortgages secured against the property if any.
Cost: The primary consideration for buying a commercial real estate is higher cost of acquisition. But now the sector has emerged with various tailor-made offerings for investors wishing to own a commercial real estate but jammed due to higher property costs. Now anyone can own a good investment in the sector having investment capacity as low as 7 lacs with attractive payment plans. So you need to evaluate your own budget and compare the return on your investment before selecting the right class of commercial real estate that fits for you.
Cost of Holding: Location is great, building is excellent and prices are also evaluated. But what is the cost of operations or holding the property with no tenants? Finally check the maintenance cost and other overheads which will be your recurring cost of holding the asset. If you are buying a property having lease guarantee from the builder, the rental so promised by the builder will be your net income and you would be saved from these recurring expenses over the leasing tenure.
Commercial Real estate is not a fated asset for big business people anymore. Rather with due diligence, basic evaluation and thoughtful considerations anyone can own a Commercial Real Estate fitted in their budget dimensions. Important is to make a wise decision and chose a correct property. With the insights shared, either you can do your own research or you can take help from various Real Estate Expert Consultancies working to ease your buying decisions and supporting you throughout the process. Happy Buying!