Commercial property is new HNI gold mine

High net-worth individuals (HNIs) are once again eyeing a larger pie of the Indian real estate market, particularly commercial real estate. One reason for their renewed interest is the increasing volatility across other asset classes and improvement in the regulatory environment in the sector.

Another reason is that commercial realty offers cash flow for investors. With yields in residential property coming down to about 2-3%, the yields offered by commercial property, around 7-8%, or sometimes even 11%, look very attractive, said experts.

Yields or returns form real estate investment are calculated on the basis of the capital value of the property and the rent it earns.

A favourable macroeconomic environment has given a major boost to the absorption rates in commercial property in the first half (H1) of 2018. Estimates reveal that around 22-24 million square feet of office space has been leased across the top cities in H1 2018, led by Bengaluru, NCR, Hyderabad and MMR. IT/ITeS sectors dominated the leasing activity, followed by BFSI (banking, financial services and insurance), co-working, manufacturing, etc, according to Anarock Property Consultants.

Why is commercial real estate attractive?

"Typically, about 30-35% of the investment portfolio of HNIs and ultra-HNIs (UHNIs) comprises real estate as an asset class. Owing to the slowdown witnessed in the residential real estate sector over the last two to three years, HNIs turned their attention towards other sectors, particularly commercial office spaces," said Anuj Puri, chairman, Anarock Property Consultants.

Besides, with the International Monetary Fund predicting India's economic growth at 7.3% in 2018, the commercial real estate market is gaining traction and is likely to remain robust during the year, he added.

According to Tejas Patil, co-head of real estate at Sanctum Wealth Advisors, one of the reasons why UHNIs and HNIs get attracted to pre-leased real estate is from a cash flow perspective.

"HNIs would consider if there is another option other than commercial real estate to achieve their goal of cash flow. Residential real estate does not offer yields more than 2-3% and is mostly for upside. Hence, investors who want more cash flows prefer pre-leased assets and commercial assets, including office spaces,'' he said.

This segment gives returns that are similar to debt investments and also gives an added benefit of owning an asset, which could offer capital appreciation in the future.

What kind of properties do investors prefer?

There is high interest for commercial leased assets among investors in premium office assets across cities. With demand for Grade A office space in prime locales rising significantly, most HNIs prefer to invest into these low-risk and high income-generating assets. They prefer to get fixed rental income, which is much higher than residential properties, said Puri.

"Typically, demand for Grade A office space is growing, while its vacancy levels are sliding south in prime locales. Besides this, the listing of India's first Real Estate Investment Trusts (Reit), expected to happen anytime soon, is also attracting both HNIs and small investors. As of now, these properties are largely commercial including office spaces that generate a rental income, likely to be followed by others, including shopping centres, hotels, etc,'' said Puri.

Just like mutual funds, Reits are investment vehicles that own, operate and manage a portfolio of income-generating properties for regular returns.

Other than commercial spaces, like a commercial IT building, warehousing is also seeing a lot of interest following the goods and services tax implementation, said Patil.

Another trend that is catching on is student housing or rental housing. It may not be a hostel per se, but a service apartment that is rented out to students or to employees of a corporate, so it becomes corporate housing.

Why student housing?

Rents in student housing can be higher than rents for commercial office spaces, said Patil. "Since parents pay for students, they don't mind if the rent increases by Rs 2,000 -5,000 in a month. They don't mind paying higher rent as compared to, say, a paying guest accommodation because the services and facilities are like that in a three- or four-star hotel - free Wi-Fi, unlimited electricity, security and someone to overlook. Also, students get to stay with people of their own age, etc,'' Patil explained.

Investors must keep some factors in mind while investing in a property being developed, such as student housing or corporate housing is the proximity to the catchment area. In other words, how close it is to the college/university or the office. "It will not work if the distance is more than 3 kilometre. Then it is like any other house in the micro market. Since you are basing your revenue and cash flow projections on the number of beds the university/hospital/corporate will rent, you can't be too far away,'' he added.

As per government estimates, there are 34 million students in the higher education space, growing at a compounded annual growth rate (CAGR) of 9.2%. With the current supply pegged at just 6.1 million beds, student housing offers massive unmet demand across the country. Thus, it has tremendous potential for both developers and investors alike, said Puri.

"Student housing provides developers a window to diversify their portfolio from the usual residential or commercial sectors. As for investors, since student housing is still at a very nascent stage in India, it offers immense potential for higher returns, much higher than the established assets including office and retail. The current rental yield for student housing segment is between 14 and 18%,'' he added.

Ways of investing in student housing?

For any investor, there are a few ways to invest in and become a part of the student housing opportunity. First is to purchase retail units directly in a particular building of the project. Secondly, investors can lend to owners or developers who are willing to take up debt, which yields better than alternate yield opportunities. Thirdly, applicable to particularly larger ticket sizes, investors can participate at an early stage with the operator or landowner to fund the project with equity monies. The benefit is that one can realise much higher yields in the range of 14-15% and also get to participate in the company valuation story in the longer run.

Future outlook

Some factors that could work in favour of commercial real estate include growth projection for India at over 7%, schemes like Make in India, start-up revolution, 100 smart cities, liberalisation in foreign direct investment policies, etc. This invariably works in favour of commercial property by increasing demand for more spaces across cities.

"Annual returns will be 8-10% in the present scenario, similar to the developed markets. For better returns, the holding period must be mid- to long-term, that is five years and above,'' said Puri.

COUNT YOUR GAINS:

30-35% 
Share of real estate in HNIs portfolio

7-8% 
Yields from commercial property

2-3% 
Yields from residential property