Trends. The plot develops for commercial property

Investment in real estate has long been a passion for the Indian wealthy. But in the past couple of years, high networth individuals (HNIs) have turned wary of the residential property market owing to tepid returns.

On the other hand, investors who bought commercial spaces — office and retail properties — have been laughing all the way to the bank. Growing demand and rent appreciation have drawn investor attention to this segment.

According to the data from Cushman & Wakefield, office space occupancy in the top eight cities increased 32 per cent in the first half of 2015 compared with the same period a year ago. Leasing activity during this period too rose 71 per cent Y-o-Y to 8.5 million sq ft (msf); grade-A office absorption area (at 6.5 msf) was over 2.5 times the area taken up in the same period in 2014.

Commercial property rentals have also been on the rise. Rent in cities such as Bengaluru rose 5-10 per cent in the first half of 2015 Y-o-Y for office spaces in both Central Business Districts (CBD) and non-CBD locations, notes a CBRE report.

In Pune, office market vacancy levels dipped nearly 5 percentage points in the first half of 2015, compared to a year ago and average rentals for grade-A offices increased 20 per cent.

So, what is helping the commercial property market? One, demand is upbeat thanks to the continued need for space in sectors, such as IT and e-commerce. In Bengaluru, for instance, south and south-eastern regions are seeing demand from IT/ITeS companies.

“The IT/ITeS segment accounts for nearly three-fourths of the office transactions in Bengaluru,” says Kuldip Chawlla, Managing Partner – Commercial Real Estate, Milestone Capital Advisors. There is also demand from other sectors, such as biotechnology, pharmaceuticals, engineering, electronics and allied manufacturing units.

“Besides established companies, there is also demand from start-ups in areas such as Koramangala,” says Satish BN Executive Director, Knight Frank, South India.

Two, while demand is steady, there is lack of new supply. Data from Knight Frank shows that in Bengaluru, supply has decreased from a high of 11.6 msf in 2010 to an average of about seven msf in the last three years, even as demand averaged 10 msf.

Three, the launch of Real Estate Investment Trusts (REITs) is expected to increase transactions in the office space, which were subdued during the downturn. Private equity firms, such as Blackstone have been acquiring prime assets in cities such as Bengaluru, Pune and Mumbai with the aim of grouping them into a REIT. Other large commercial property owners, such as DLF, are also planning to list their assets as REITs.

REITs act as an investment vehicle between investors and developers, providing an option for retail investors to earn income from rent-yielding assets, such as office and retail space.

Rental yields of over 8 per cent in prime properties could make net returns (after management expenses) still attractive for many foreign investors looking for stable income.

The basic thumb rules followed in buying residential property — location, quality, size and features — apply for commercial property as well.

There are two main categories within the commercial space. One is the retail segment that includes malls, retail stores and shopping complexes. The other is the office buildings segment.

In the retail segment, ground floor with a good frontage as well as parking availability are important, says K Mahalingam, a business owner and commercial property investor in Chennai. He notes that letting out properties to banks or food outlets may be better choices compared to retail store spaces.

“There is a fear that there may be substitution from online portals. So, spaces where consumption happens on the spot may be a safer bet,” he says. In the office space segment, slightly different factors come into play.

For instance, in Bengaluru, office projects along the Sarjapur ORR corridor are sought after due to factors, such as proximity to the CBD and major residential markets, good infrastructure, access to large talent pools, availability of contiguous land parcels and presence of hotel and retail projects, says Satish. Whitefield saw a 9-10 per cent sequential rent appreciation in the June quarter of 2015, according to data from CBRE. Smaller spaces may be better bets due to client preference. “We have already started witnessing reduction in office sizes. In future, large companies as well as MSMEs would prefer to operate out of smaller offices at prime locations,” says Atul Chordia, Managing Director, Solitaire, a commercial property developer. In cities, such as Chennai, there is lack of supply for 2,000 to 10,000 sq ft office spaces, says Mahalingam.

Among cities, Pune has been a great market for office rentals. This is thanks to good IT infrastructure, lower capital costs compared to Mumbai and decent return on investment, says Chordia.

Rental returns for office space vary based on the grade of property. But for spaces in the price range that most HNI investors can afford, 5-6 per cent return is reasonable, says Mahalingam.

Commercial spaces are taken on a long-term contract as businesses want stability of location. Lease agreements are usually for about nine years with rent escalation clause every three years.

That said, Mahalingam advises investors to budget for loss of income due to vacancies. There is also a risk that tenants may refuse to vacate.

It is, therefore, important to have a tight legal contract. The capital return you can expect is based on the future rent potential as well as land price appreciation. For those who love the high-adrenaline rush of investing in real estate to reap high-returns, commercial property could be a good way to balance your portfolio.

While you can make money through capital appreciation when you sell, the income component serves as a good hedge and offers stability.

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