Skip to main content

Look beyond residential investment options

Everytime, I speak to an average property investor looking for investment opportunities, nine out of 10 chances are that he or she is in the market looking for residential options. Either it is a second home with scope for appreciation or it is an apartment with potential to rent. Sometimes it is just the neighbour’s flat two floors below! 

For some of these investors, this preference for residential property may be part of a well-thought out investment strategy but for most it just happens to be the default option. 

Why’s that? Largely because we all are comfortable dealing with residential real estate as an asset class. Typically , anyone looking to invest in another property would already own their present home and hence buying an investment with similar physical and commercial characteristics is just so much easier to deal with. 

It is a fact that buying an office space or a retail store would not even cross the minds of most such investors. In fact, why even bother? 

Well, there are a few good reasons why you should bother. 

For starters, rental yields in commercial property tend to be much higher compared to residential. In India , you can acquire a commercial property that has an existing tenant with several years to go in the existing lease agreement. Such a property can pay you 11-13 % per annum of the property cost as gross rental income. A comparable number for residential properties would be in the 3-5 % range. If you are looking at the rentals to pay off your mortgage, it is easy to see which asset class makes more sense. 

Further, real estate is a cyclical business . Often, residential and commercial real estate cycles operate differently. If you have a significant investment in your existing home (residential ), it may be wise to make your next investment into a commercial property that could move according to a somewhat different market cycle. An example is the Mumbai market today — residential prices are going through the roof while commercial prices are just recovering from the bottom. When investing, it is never a bad idea to diversify . 

Other fringe benefits include leases that tend to be longer for commercial premises with built-in rent escalation clauses. Typically, commercial tenants would maintain the property better as it is their place of business. Finally, if you have an existing tenant, it is much easier to exit commercial as there is an established market for such properties. 

Of course, there are disincentives too. The level of financing that you can secure from a bank would be lower for a commercial property (50-60 % LTV) compared to residential (70-80 %) and that too at a cost higher by 200-300 bps. Tax benefits that you may get under a residential mortgage would be non-existent in case of commercial. The overall transaction size could also be higher for commercial properties though you could search and find smaller options as well to suit your budget. 

You also need to bear in mind that commercial properties tend to have a greater correlation with the overall economy compared to residential. In case of a prolonged downturn, rentals would fall and vacancy levels would rise. Outgoings are also typically higher for commercial buildings which can be a drag in case of a vacancy. Given all this, it is important for you to get some expert advice on where and what to buy. 

So obviously it is not a slam dunk. But nothing in life is. The idea is to open your mind and at least evaluate the property investment world beyond residential. 
(Ritesh Vohra is MD, Real Estate, Saffron Asset Advisors)


Above article is from economictimes