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Invest in the Commercial Property Space, But only After a Reality Check

High net worth individuals (HNIs) are betting big on commercial real estate these days. According to wealth managers, many rich individuals are either buying under construction properties with an intention to sell them later, or buying completed and pre-leased properties for regular rental income. If such stories are prompting you to take a look at the commercial real estate space, you should keep in mind that investing in a commercial property is very different from investing in a residential property. First, the sheer cost of the property permits only those with deep pockets to invest in such properties. Second, you have to study the infrastructure developments around the property apart from document and price check when it comes to investing in a residential property. On the other hand, you have to look at the demand-supply dynamics, study the location, look at the job market and so on while investing in a commercial property. Here are some factors you need to bear in mind while zeroing in on a commercial property:

Formula 1

"Investors in commercial space need to establish the soundness of the location and its demand/supply dynamics to avoid buying into a micro market which has or will have high vacancies. They also need to ensure that the economy, job market and population growth in the market is healthy," says Sanjay Dutt, CEO, business, Jones Lang LaSalle India. "They should also establish the potential for further infrastructure development in the area, which needs to have proper access to public transport. Finally, the project to be invested in should be professionally managed," adds Dutt.

Needless to say, this is the key determinant. And, commercial real estate, due to its inherent income-generating ability, naturally commands a premium. "Areas of commercial activity, shopping areas etc are better choices," says Raghvendra Nath, managing director, Ladderup Wealth Management. "Standalone office buildings in non-commercial areas may fetch lesser rentals and have lesser potential for appreciation."

Next on your agenda should be evaluating the rental income the property can yield. While location would be the main parameter dictating rental rates, you need to take into account other factors too. "While the rental yield largely depends on market conditions, one could still benchmark it against a band of 8% to 12% per annum," suggests Gulam Zia, national director, research and advisory services at Knight Frank India.

Investors need to take informed decisions on under-construction commercial projects, regardless of location and the developer. The same negative financial dynamics that are compromising completion dates of many residential projects can hold true for office buildings. "HNIs are primarily interested in income-generating commercial assets, and therefore, tend to prefer investing in completed, fully-leased projects by reputed developers so that cash flows are assured," says Dutt.

In fact, wealth managers are recommending purchase of properties that already have an income-yielding track record to show. Buying such pre-leased properties eliminates the uncertainty risk in the decision. "There has been a steady growth in HNIs investing in pre-leased properties for rental returns. The biggest advantage on such investments is the price appreciation that can happen and show investment growth in multiples," says Zia.

"We ensure the project is incredible hands or even pre-leased so that the investor doesnít have to worry about return on investment. In fact, we have also advised our clients to invest in leased warehouses which show tremendous growth potential and certainty of return," Anshu Kapoor. head, private wealth management, Edelweiss Capital. However, buying a pre-leased property cannot be termed as foolproof investments as you still need to factor in the lessee risk. "Clients opt for preleased properties as they can immediately have an income stream. However, if the lease is terminated because of the lessee moving out, there is a disruption in the income stream and the risk of delay in getting a new tenant," says Raghvendra Nath. The same would be applicable while buying properties with the objective of finding a tenant later. ďOne of the most important decision for office property investment has to be the kind of tenant or occupier who could lease the property. This will decide the marketability of the property, i.e. how easy or difficult is it to find a tenant," adds Zia.

"Owners of pre-leased properties demand a premium to the market rate. So it is important that one negotiates properly to bring the price as close to market rate as possible," says Raghvendra Nath.

"Then there are other hygiene conditions like age of the building, facilities and amenities provided the property, the maintenance charges, property taxes etc that you need to study before going ahead with the purchase," advises Zia.

Avoid making short-term gains in real estate through flipping (buying at lower price and selling at a higher price) to benefit from the arbitrage. "We donít advocate flipping as it can be risky, especially at times when registrations have seen a slowdown in the real estate segment," says Anshu Kapoor. Ideally, an investor should look at a time horizon of 5-7 years to compute actual gains, suggest experts.

Wealth managers are advising their HNI clients to look at investing in upcoming commercial pockets in metro cities

Expert believe
emerging commercial spots can yield higher returns compared to established central business districts in the metros. Location and cost apart, investors need to factor in the rental yields, state of completion, developerís reputation, age of the building, amenities and taxes while making a decisionExtra caution should be exercised while investing in under-construction commercial projects, regardless of the location and developer Pre-leased properties can be considered to reduce the element of uncertainty as they give access to the existing stream of rental income. Negotiate hard on the price, though.

Source : ET, March 2,2012