Investing in Commercial Real Estate vs Residential Real Estate: A Comparison of Rental Yields

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Indian real estate is once again poised for rapid growth. It is holding firm, supported by strong economic sentiment and low interest rates. Along with end-user activities, investments are stimulated.

Meanwhile, the age-old debate over whether to invest in Commercial Real Estate (CRE) or Residential Real Estate (RRE) is resurfacing. Both asset classes have advantages and disadvantages. There is no standardized set of parameters that can be used to compare CRE and RRE. On the other hand, in terms of rental yields, CRE clearly outperforms its residential counterparts. Tertiary assets such as offices, shops, warehouses, etc. remain safe bets because they can generate recurring rental income.

Rental yields in CRE are higher in India

Globally, housing rentals can be a source of smart returns. London city center can easily provide a 4.5% return. Similarly, Dubai and Bangkok can post returns of 5.5% and 5.3%, respectively, creating a favorable environment for increased investor participation.

However, the same view does not apply to the Indian market. In India, the rise in rents has not followed the rise in real estate prices.

Housing yields vary between 2 and 3%, which is significantly lower than in international markets. In Delhi NCR, rental yields are just under 3%. It is generally between 2.5 and 2.7% in the Mumbai Metropolitan Region (MMR). South of Bangalore, the upcoming IT corridors have the potential to generate up to 3.3% (general average is 2.4-3%).

Meanwhile, furnishings or other added value can boost yield by 25 to 50 basis points. However, they cannot be increased beyond a certain point.

Commercial properties, on the other hand, produce significantly higher returns. Class A office spaces can easily deliver an average return of 6-7%. The increase in economic activity, combined with a stable macroeconomic outlook for FY23, bodes well for the country’s commercial leasing sector. Meanwhile, after an extended period of remote working, most organizations are implementing return-to-office initiatives, which is fueling demand.

Retail trade is also picking up after being disrupted by the pandemic. FY23 is expected to see an increase in transactions in high street, hypermarket, supermarket and mall spaces, among others. Retail units can offer returns of 8-9% and are a safe investment option.

Alternative CRE assets to consider investing in

Other business subcategories are also climbing the curve and attracting investor interest. For example, warehousing is attracting a lot of interest from investors. According to research by Knight and Frank, warehousing transactions totaled just under 2.95 million square feet in FY21, up significantly from 1.29 million square feet in FY21. FY20. The warehouse market in India continues to grow owing to the growth of consumer internet, packaged food, FMCG, etc. Warehouses in India can easily generate returns of 5-6%, which is much higher than the residential market.

Commercial assets will be the preferred investment option at a time when there is a growing appetite for low risk, high return investments. Despite the effects of rising oil prices, India’s economy will continue to improve in the current fiscal year, creating a conducive environment for commercial leasing. Meanwhile, the residential sector will experience positive expansion, fueled by a growing middle class and increased urbanization. However, rental yields will remain in the low range, weighing on overall ROI.

Written by Ankit Aggarwal, MD, Devika Band

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