Investing in Pre-leased real estate, and real estate in general can be tricky. Investing in real estate is not as straightforward as investing in other asset classes such as equity because qualitative factors, as compared to quantitative ones, also play an important role here. In this article, we will look at all these factors which are a part of any pre-leased real estate investment –
Location: This is perhaps the most important factor that determines the value of any real estate asset. An investor should make sure that the location serves the purpose and is right at its price in terms of accessibility and footfall. A prime location will always command a higher value and would result in lower turnaround time in case you plan to sell it. Appreciation in the asset’s value will be determined by its locality and the appreciation in the locality. The same goes for rental, which will always be measured in comparison to similar premises in the area.
Lease Terms: After location, the biggest factor is the lease and its terms. There are numerous details about the tenant’s lease that warrant an investor’s attention. The Lease Tenure is the maximum period that the tenant can occupy the property without being forced to renew the lease or vacate the property. The lease tenure determines the period of assured return for the investor. The more favorable the lease terms, the higher value the property commands. For e.g. A property with a Fresh Lease will have a significantly higher asking price than one which is in fag end of its total lease tenure as it guarantees a higher period of assured returns from the date of investment.
The Escalation of Rent refers to the periodic appreciation of the monthly rental as per lease agreement. For e.g., Tenants can opt for an escalation of 15% or 12% every 3 years, 5% every year or any other terms as per negotiation. A higher escalation results in a better yield. A lower period between each escalation will also have the same effect. A 15% escalation every 3 year for a 9-year lease tenure would bump up the annual ROI from 6% to almost 8% at the end of the 6th year. A longer lease tenure in the same case, say 25 years, or a shorter escalation period in general (like yearly escalation) would have a compounding effect on the rental and result in even better yields.
The Lock-in Period is the minimum period the tenant is required to occupy the premises, in violation of which it’ll have to pay a huge penalty. Naturally, the higher the lock-in period the better. The Security Deposit is the amount that the owner has as security in case the tenant decides to vacate the property abruptly. Again, the higher the better.
Rental Yield is the annual rent generated by the property against the total investment put in. Office Spaces tend to have a rental yield of 5-7%. Retail spaces and shops have a slightly lower rental yield and banks offer the least return in terms of rent. Rental Yield is directly dependent on the kind of locality and the perks associated with the locality. Perks could range from a safe locality and accessibility to cleanliness and footfall. Other factors that are equally as important are building maintenance and occupancy. If the building is poorly maintained, it will have a poor occupancy rate. Also, no high profile (or even good tenant) will occupy a poorly maintained business complex.
Price per sq. Ft: Price per sq. ft. is the total asking price per sq. ft. of area. This could be over the carpet area or the built-up area. The locality’s price per sq. ft. determines the asking price. The property being considered can command a slight premium on account of a few perks or favorable terms, or a discount owing to certain negative factors.
There are certainly other factors that need not be explained but should always be kept in mind such as the Total Built-up Area, Tenant, and Efficiency.