Investing in the office market

Low residential yields have pushed commercial real estate investors to fresh avenues that promise profit and stability

Low residential yields have pushed commercial real estate investors to fresh avenues that promise profit and stability

Investors are once again drawn to the real estate sector in India. Attractive appreciation potential, recurring rental income, and the tangible nature of the sector have resulted in renewed investor interest. Meanwhile, the crypto and other financial markets have also softened after a recent bullish run, which is further diverting investment into the real estate sector.

When it comes to real estate investing, as a thumb rule, commercial real estate is preferred over the residential market, as the former is a better option to earn rental yields. Within the commercial segment, offices are once again becoming the favourite.

moving ahead

As the crisis has de-escalated and a more enabling growth environment has taken over, office demand is picking up fast in most of the major cities. Most organizations are aggressively implementing back-to-office programs, resulting in a significant increase in office absorption. This is also resulting in investors gaining confidence in the asset class.

Another advantage for investors is the subdued prices of office stocks. In 2021, as per the CBRE South Asia report, the total leasing activities in India amounted to 41 million sq.ft, growing by 16%. However, the very same year, a total of ~ 50 million sq.ft. of new office supply entered the market, which has taken the total cumulative supply to 773 million sq.ft. An oversupply in the market would be a blessing in disguise for discerning investors as they can acquire the asset for affordable prices.

In India, offices offer much higher rental yields. There are multiple factors that dictate the yields including tenant profile, macroeconomic conditions, market situations, and much more. However, if invested prudently, offices can easily give yields to the tune of 8-10%.

In contrast, residential yields have been historically low in India. In most of the metros, the yield range between 2-4% in the housing market. Another category that can give attractive yield could be retail. However, retail in India is still reeling under the pressure of low occupancy.

As per Knight Frank’s research, average vacancy rates in shopping centers are north of 19%. The softened demand in the retail segment is rooted not just in the pandemic but also in poor asset utilization. Industrial assets, logistics, and warehouses have also seen a rise in investor interest in recent years. Such assets can post yields in the range of 9-10%.

However, finding tenants is cumbersome. Moreover, there are a lot of maintenance activities required for such asset classes. This further makes offices one of the safest and most suitable assets to bet on.

The office is also a great asset for diversifying and spreading portfolio risk. While financial instruments are erratic, real estate assets such as the residential market give sub-optimal returns. In contrast, investing in the office market is not only safe but can also give concurrent rental income. Meanwhile, offices can also give a decent capital return, provided they are held for mid to long term. (On an average, before investing in an office asset, one should have a holding period of around five years.) In the foreseeable future, offices will continue to gain momentum in the country.

After the virus softened the stance of the economy in the last two years, the economy is once again on a strong footing. It is set to grow at over 8% in the current fiscal. Meanwhile, growth in commercial activities will continue to steer office absorption.

The writer is partner, RPS Group.

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