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Commercial Real Estate: creating Growth for Investors
Let’s get some perspective about how the Indian real estate sector looks like today and where it may go tomorrow:
The size of the Real Estate sector:
The real estate sector is huge in India. By 2040, the real estate market will grow to Rs. 65,000 crore (US$ 9.30 billion) from Rs. 12,000 crore (US$ 1.72 billion) in 2019. Retail, hospitality, and commercial real estate are also growing significantly, as a part of this market, as they continue providing the much-needed infrastructure for India's growing needs.
Commercial Real Estate (CRE):
Real estate is primarily divided into residential and commercial. As the focus of this article is on CRE, let’s understand where it stands. The office market in top eight cities recorded transactions of 22.2 msf (million square feet) from July 2020 to December 2020, whereas new completions were recorded at 17.2 msf in the same period. In terms of share of sectoral occupiers, Information Technology (IT/ITeS) sector dominated the highest market share of commercial real estate, followed by BSFI (Banking, financial services and insurance) and Manufacturing sectors.
What are the CRE (Commercial Real Estate) hotspots?
TKey investment destinations include Bangalore, Delhi NCR, and Mumbai, which together account for more than two-thirds of commercial investment activity. Emerging metro cities of Pune, Chennai and Hyderabad, primarily driven by a strong IT industry have also seen significant interest in the recent past.
Four Reasons to invest in CRE:
1. Higher Returns:
While yields from residential properties are between 2-4%, commercial properties offer around 8-11%, depending on the quality of asset and leases.
In fact, over the past 5 years, Due to rental yield and capital appreciation. In India, commercial property has grown at a 16 % compound annual growth rate (CAGR) over the last five years. In this period, NIFTY has grown at a CAGR of 14%, making commercial properties a very attractive investment.
2. Lower Risk:
In financial markets, higher the returns, higher the risks. Stock markets are an excellent example of this- fluctuating a lot in value frequently. Compared to this, CRE has far lower risks. Some risks in CRE are:
- Credit default / Vacancy risk: Having no tenant, or a tenant failing to pay lease, leads to no rental yields, thus disrupting the regular income from CRE. This can be mitigated by securing lease contracts with established businesses that aren’t likely to vacate the property and won’t default on their payments.
- Liquidity / Market Risk: Real estate is quite illiquid as compared to equity- thus getting out of investments profitably can take time. One can mitigate this by investing in locations that have high demand, like business zones, where one will easily find investors interested to buy their property should they need to sell. This brings us to market risk, which is the risk of the market value of the property not growing as per expectations due to changes in the neighborhood. This too can be mitigated by choosing the location with due diligence while investing in CRE.
3. Regular Income Stream:
One of the biggest advantages of CRE is the regular income investors receive in the form of lease payments. While this can be achieved through fixed income securities as well, the returns are hardly comparable. For comparison, the Indian sovereign 10-year bond yield is 6%, while CRE gives around 8-11% rental yields- this gives CRE a great advantage over fixed income.
4. Beat Inflation:
Real estate has always been considered a good hedge against inflation. Whenever prices rise, CRE prices often rise higher than them. Thus, having CRE in your portfolio gives you a good protection against inflation eroding your wealth away.
On top of that, it has a low correlation with other asset classes, providing diversification to your portfolio. David Swensen, manager for the Yale Endowment advises investors to invest 20% of their investable wealth into real estate in his book "Pioneering Portfolio Management".
To summarize, CRE is a great investment option because it offers you great returns at low risk, gives you a regular income stream and offers protection against inflation, and also diversifies your portfolio.