Play safe with commercial property

High returns are a lure for investment in office space, but both loan-to-value and tenures are lower.

Property consultants say sluggish volumes in the residential sector and hardening interest rates have come as a boon for retail investors in office properties.


Today, in Mumbai, investors can own smaller units of space, of 500 to 1,000 sq ft, in Grade A buildings (those centrally air-conditioned and with standard amenities), in contrast to a few years earlier, when only larger units were available, says Ramesh Nair, managing director, West India, Jones Lang LaSalle (JLL), an international property consultant.

"If you look at Lower Parel (in south-central Mumbai), you can own office space for Rs 1.5 crore, which was not possible a couple of years ago,” says Nair. While residential prices are upwards of Rs 20,000 a sq ft, office values are at Rs 15,000 a sq ft in Lower Parel.

Rental yields have also shot up from 9-10 per cent to 12-15 per cent in the past couple of months, due to increase in interest rates and borrowing costs. Rental yield is the amount of money an owner receives in rent over the course of a year and expressed as a percentage of the amount of money invested in the property.

"If you prefer higher yield and low upside, investment in office properties is a better bet,” says Prakrut Mehta, national director, office and industrial agency, Knight Frank India.

Besides, the advantages of small units are that it is easier to find tenants and the premises can be used for business by their owners if they happen to be of a entrepreneurial bent.

According to JLL, the demand for office space in India will be around 200 million sq ft over the next five years. Post the global financial crisis, the prices across most markets dropped 35-40 per cent and have bottomed out in most markets, offering investors a good opportunity to buy into commercial real estate.

Nair says there is an almost 50 per cent jump in absorption of office space in the past two years.

RISK FACTORS
But retail investors should not forget that the office market was hit hard during the property slowdown of 2008-2009 and the last one to recover from the lull, as companies and financial institutions deferred leasing transactions

“It is a high risk, high return investment segment. Investors should bear this factor in mind,” says Mehta of Knight Frank.

High vacancy levels are also one of the risks associated with investing in office properties.

According to JLL estimates, vacancy levels in office properties across the country have risen from two to three per cent to 18-19 per cent due to increased supply over the years.

“Investors need to study the demand and supply dynamics in a particular location where they are investing. If they do not engage in sufficient research, they may end up buying into micro markets which have or will have high vacancies,” Nair adds.

There is also a restriction on bank funding. Banks lend only up to 60 per cent of the loan to value ratio to buy commercial properties, subject to the borrower’s adequate net worth and established ability to repay. Again, the loans are given subject to a maximum of seven years.

"Your equity contribution is higher and tenure is fixed. You have to tackle these two issues,” says Mehta.

Investors also need to check developer credentials, potential for infrastructure development and quality of project management before deciding.