Real estate has been the beacon of investment in India. Investment in commercial and residential property is regarded as a high grade investment as it offers a tangible natural asset.
Investment in commercial and residential property has seen massive shifts in the last 10 years which have made real estate an even more lucrative investment. Commercial real estate market has grown substantially in recent decades as India has been experiencing an economic boom, more business houses have been established in India. The country has seen 7 times growth in the number of new businesses in the last decade. Due to this rise, the demand for commercial property has increased. Residential properties on the other hand, have proven to be a sustainable option as they are usually purchased for end use by the buyer or for the purpose of long term investment. The question that arises is where should one invest - Commercial or Residential?
INVESTMENT IN COMMERCIAL AND RESIDENTIAL PROPERTY - A QUESTION
INVESTMENT IN RESIDENTIAL PROPERTY
- Rising Demand of Rental Properties: The current generation of youngsters prefer renting over purchasing a property. This is because of the changing nature of jobs. Current jobs require people to travel more, there are frequent transfers and these are less static. Moreover, youngsters don’t mind moving from one geography to another in order to grow. Hence, they prefer renting over purchasing a property. The rental market is bound to rise manifolds in the coming years, which can guarantee a high return to investors.
- Ever Growing Demand: There will always be a demand for residential property because everybody needs a place to live. With the growing population of India, the number of new home buyers are increasing. This opens a wide spectrum of investments for the residential real estate market.
- Low Cost of Market Entry: Residential properties require a lesser initial investment to enter the realty sector. Small and medium investors find it easier to invest in the market due to low cost of market entry. This is because commercial properties are generally required for business purposes, the property becomes a business asset. It is required for doing business, on the other hand residential properties are majorly required for personal purposes. A commercial property in a tier-1 city may start from 5-10 crores while a residential property in the same city is half the price.
- Higher Risk: Frequent changes in tenants with low returns make investment in residential property a less favourable choice for some investors. Additionally, fluctuations in residential property prices are influenced by many factors other than the general economic scenario. It depends on the market sentiment as well. This is in contrast to the commercial properties where the factors determining the prices can be understood more easily and strategies can be formulated well in advance.
INVESTMENT IN COMMERCIAL PROPERTY
- High Rental Returns: One of the best reasons for investing in commercial real estate over residential is higher rental returns. Commercial properties offer a higher income potential yielding annual rental returns between 6-12% depending on the area, where as residential properties yield only 1-2%
The reason for this is: Commercial properties are used for doing business, the rent is paid out of the income received from the business, the property becomes a prerequisite for business and hence stability can be achieved. For eg: A commercial property is rented to a retail outlet, the retail outlet grows with time, for such spaces, the location is a major factor in growth, now the business owner would always prefer keeping the same property, even if it means paying more rent. This benefits property owners in the long run.
- Higher Initial Cost of Investment: Entering the commercial real estate market requires a lot more capital than residential, for the same area. The high initial cost of investment makes its investment option less viable and restricts the entry for small investors. With large initial investments come running large following capital expenditures. This increases the risk as well, as the investment once done can not be recouped easily. It required more research about prospects and a long term view to predict the rate of returns.
- Interest Rates on Loans: If an investor wants to take a loan for his/her commercial investment, then he must be ready to pay a slightly higher interest rate. The interest rate for home loans is much cheaper than interest rate for commercial spaces being 1.5-5% higher. The loan factor must be taken into account while making the purchase decision, as it sets the lower limit to the returns to be expected. For eg: Property Price: 10 crore, let’s say we take a loan of 5 Crore, the rate of interest is: 10%, so the interest, if we only pay the interest cost, comes out to be 50 lacs per year. This clearly means we need a property where rental would be more than 50 lacs per annum taking into account the upkeep costs, otherwise we will lose money. If the rent is less, we need to decrease the debt component in our capital structure and maybe take a partner.
On the other hand we need an year on year appreciation of more than 5% which is the inflation rate to make a capital gain. Even on a 5% appreciation we are still in profits, as the value of money taken from the bank remains the same because we will be paying the interest out of the rental income.
Hence, the debt risk might be controlled with proper planning and research.
- Increased Effort: Although the commercial property will yield a higher return than residential, it will require a high amount of effort for the investor. The property must be chosen at a suitable place where the demand for commercial property will be higher in order to earn a higher rental income. It is a must for the investor to check the creditworthiness and the profile of the tenant. The tenant should have a stable and long term business.
- Introduction of REITS: Investing in commercial real estate can be difficult and in order to make it easy, a new innovation was introduced: REITS, Real Estate Investment Trust. In the early 1960’s REITs were introduced in the US with an outlook to change the real estate market. Since then, REITs have been adopted by other countries as a preferred mode of investment. This system has helped small investors to make a productive contribution towards financing in commercial real estate. REITS adds to the advantage of investment in commercial property over residential.
- Key Markets for Investments: Some of the major markets for investment in commercial and residential property are Delhi NCR, Bengaluru and Mumbai Metropolitan Region also referred to as MMR. With better job opportunities and MNCs occupying a big chunk of land for their operations, Commercial Real estate is blooming. Residential real estate is also witnessing a high demand for locations that offer good connectivity and are closer to major job hubs.
Investment in commercial and residential property: Conclusion
Any form of investment is a good investment if made congruously. Investment in commercial and residential property come with their own set of pros and cons that make them highly distinguishable. It depends on the investor’s expectations and his paying capacity. With the real estate market growing at a hearty pace, investment in commercial and residential property both have a positive outlook for growth, hence it is a win-win situation. An investor may even form a portfolio of both types to diversify his risk and guarantee himself a fairly higher return.
Note of Precaution: The investor must check all the documents carefully with the due diligence before investing in any such arrangement.