Top Factors to Consider Before Investing in Commercial Real Estate – Forbes Advisor INDIA

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Investments can be as simple as saving in a bank or as intensive as trading through the stock market. Depending on the complexity of the mode of investment, time and effort are spent. Investing in real estate is an option worth considering for those looking for investments that involve a longer period of time.

There are five main types of real estate investments, one of them is commercial real estate. Here’s how commercial real estate works and how you can add it to your investment portfolio.

Why choose to invest in commercial real estate?

An investment in commercial real estate usually involves an investment amount which is a large sum to provide for a single retail investor. The most common ways to invest in commercial real estate (CRE) are through real estate investment trusts (REITs) or through co-ownership.

This mode of investment reduces an entry charge into CRE for retail investors by reducing the size of the ticket. But a reduction in ticket size does not necessarily mean that an investment option is good.

CRE investing has some advantages over other traditional investment options:

  • Being real estate, it is insulated from market fluctuations. As a long-term investment option, it is stable and generally has a constant rate of return.
  • It comes with a lock-in period that protects your investment while guaranteeing returns.
  • Any special purpose CRE in a key location can be a literal goldmine as it will be highly sought after by a niche segment of tenants, thus also ensuring that a renewal of investment continues to generate returns in the form of passive income.

How to start investing in commercial real estate?

Investment in commercial real estate can be done on an individual basis, but the high cost of investment makes it difficult for a single investor to invest the required amount in a commercial real estate entity.

The preferred method for investing in commercial real estate is to invest in REITs or condominiums.

REITs: These work much like mutual funds. There are fund managers who manage a REIT, and your investment is part of the investment pool which is divided into several assets. These assets are selected by fund managers based on their historical performance and market dynamics. Returns on all assets are clubbed and distributed to investors based on their investment in the REIT fund.

Condominium: This helps like-minded investors pool their investment amounts to own an asset. The minimum note size normally remains in multiples of lakhs. Depending on their risk appetite and funds, individual retail investors may hold one or more fractions of an asset, granting them a portion of the ownership. Returns for rent and capital appreciation are paid into each investor’s property report.

The main difference between the two modes is simple – in a REIT, whether you like it or not, some of your investment could sit idle in an asset that is not attracting tenants for whatever reason. The only way to prevent your investment from becoming an expensive paperweight is to withdraw from the fund altogether.

Whereas joint ownership gives you complete control over your choice of asset. In co-ownership, you can still stay invested in other profit-making assets and stop, sell, or swap your fractional ownership of one non-performing asset for another.

How to go about investing in commercial real estate according to objectives?

Goals-based investing works almost the same as investing in any other traditional model. CRE is ideal for long-term investment goals. So if you’re looking to invest for less than three years in a row, you should probably look elsewhere.

In long-term investments, the goals are larger, well-planned and comparatively spread over five years or multiples thereof. The simplest and most readily available option for investing in CRE at any given time is commercial office space, followed closely by warehouses. The rarest variety is found in laboratories, manufacturing units or assembly workshops.

Office spaces: Office spaces generally tend to be stable investments for at least four to five years if the company has not set up a headquarters or headquarters. In this case, the duration of the lease may go up to 10 years with the possibility of subsequent renewal, which will be requested by the tenant.

Warehouses: Multi-purpose warehouses are used for the storage of goods in transit, as a supply hub, or to support a nearby manufacturing or industrial unit. If the tenant is an established e-commerce player, and there is good activity in the area, you can rest assured that the investment will be stable over a long period such as 15 years. Otherwise, most warehouses come with a lock-up period of five years and an 11-12 year lease.

Laboratories, manufacturing units or assembly workshops: The final category of manufacturing, research and industrial space is rarely vacated by tenants. The only opportunities you can get to invest in it are when new assets appear or a tenant decides to sublet part of the asset. Tenancy remains stable as a rock, with tenures spanning 20 years or more. Capital appreciation is steady and rental yields continue.

Depending on what you are looking for, you can choose to invest in any of these subclasses depending on your ideal financial goal.

What factors to consider before investing in commercial real estate?

As with any type of investment, proper research should focus on factors crucial to CRE assets. Here are the main factors you should keep in mind before investing in commercial real estate:

1. Location

Location plays an important role in deciding the performance of your asset. This applies to both residential and commercial real estate.

Accessibility by roads and railways, major highways, proximity to airports and seaports are factors that can make or break the value of the asset and its appreciation over time. A well-connected location near ports and harbors can be ideal for tenants who are in manufacturing and export or import from other countries.

The same location won’t work very well for companies that deal with software operations. When investing in a large urban market, be sure to also keep an eye on the micro markets in and around the asset you are interested in, for any changes that may affect your investment.

2. Rental

Existing tenants, their financial situation and the conditions they are currently in are factors that can tell you a lot about the long-term viability of the asset and how beneficial your investment will be.

Historical data on rental conditions and vacancy will give you an idea of ​​what to prepare for in the event of a rental interruption during the period you decide to invest. A general-purpose office space is likely to have a higher chance of being occupied than a special-purpose warehouse or lab. However, the latter can overtake the former thanks to better capital appreciation and a much more stable rental.

3. Market dynamics

It is true that commercial real estate does not suffer from the same market movements as most other traditional investment options. However, market developments affect vacancy rates, rents and occupancy stability. A very relevant case can be made from the Covid-19 pandemic. With people not coming to offices to work, a number of markets have seen commercial office rentals plummet.

Keeping tabs on businesses that are driving the economy is a great way to figure out which commercial real estate asset is the one you should be looking for next.

4.Documents

If you are going into CRE investing on your own, without the help of an advisor, it is ideal to have adequate legal support to guide you through all the legal paperwork to check for hidden fees, ambiguous ownership clauses, among others.

If you opt for REIT or co-ownership to enter CRE investing, most of the above factors will be handled by the team managing the investment, sale or resale of the assets. The most important thing you would then have to do is to set a goal for what your investment should achieve.

What should you remember before building your commercial real estate portfolio?

People normally tend to blow the scales when talking about the returns they get in any type of investment. It may be history, but not everyone has the same appetite for risk, or the same level of forbearance and patience to complete a long-term investment.

Key points to remember when deciding to make a CRE investment include:

  • Investing in CRE is only beneficial in the long term.
  • Investing in a single asset class is not a good thing; learn to diversify.
  • If the CRE is a solid asset, it carries its risks; beware of “guaranteed returns”.
  • Different markets behave differently; one rule of thumb does not apply to everyone.
  • The market vacancy rate and rental rate play a major role in determining rental yields.
  • If an asset shows no promise of appreciation in five years, talk to your financial advisor or investment manager.
  • Holding assets is good, trading them is good too. Use your discretion.
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