myrecapital

Introduction to Commercial
Real Estate Investment

In India, commercial real estate has become the preferred investment avenue for High Net Worth Individuals and Institutional Investors due to the attractive yearly yields (8%-10%), annual capital appreciation (15%-25% IRR), and secured long-term leases with MNC tenants. Traditionally this asset class has had high barriers to entry for retail investors and has seen limited participation from retail investors. Whilst evaluating a property, individuals often allocate significant importance to the financial and economic metrics of the transaction. However, to ensure the long-term durability and stability of the property, it is also imperative to understand and thoroughly evaluate the building quality.

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Commercial Real Estate Investment can be categorized into three Asset Class namely

Class A

Class A refers to the category of buildings located in high-growth micro-markets and tends to outperform other buildings in the vicinity with respect to vacancy rates, rentals, and demand. These buildings are usually professionally managed and maintained to ensure that the asset stands the test of time and reflects minimal deterioration with age. For an investor, Class A assets provide a relatively stable income profile, minimal extended vacancy risk, and modest expectation of capital appreciation potential. They typically have a consistent rental yield and higher purchase price due to the limited supply of such properties.

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Class B

Class B buildings have a higher risk of vacancy and lower construction quality. These buildings display signs of wear and tear over time and tend to deteriorate with age. These properties typically trade at higher cap rates and generate high rental yields for an investor to factor in the associated risk. Whilst the yield can be tempting, it is important to consider the long-term performance of the asset, tenant ability, and vacancy risk. There may be some potential opportunities for "value add" redevelopment/refurbishment if one has execution capability and the corresponding risk appetite. Successful "value add" projects can convert a Class B building to a Class A building, but the capital commitment and risk in doing so is significant.

Class C

These properties often have outdated fixtures that often require significant upgrades to make the premises tenantable. These buildings are usually vacant or have compromised rentals. To generate stable cash flow and maintain the structural integrity of the building, investors will often have to invest significant capital in the up-gradation of the asset. Such investments are usually not recommended for retail investors due to the high level of expertise required in converting the building into a performing asset.

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Why is commercial real estate a secure investment avenue?

Intelligent investors are always trying to get the best risk-adjusted returns in volatile markets and changing conditions. To optimize one's risk exposure, it is vital for investors to diversify their portfolios across various investment avenues, including debt, equity, real estate, commodities, and fixed income. Retail investors increasingly recognize the lucrative return profile of CRE and the importance of this asset class in their investment strategy.

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  • Commercial properties are considered cash flow products because there's a steady stream of rental income from MNC tenants secured by long-term registered lease agreements. These lease agreements can extend for 9-15 years and are seldom violated by such tenants. MNC tenants usually invest significant capital in the upkeep of the premises, fit-outs and furniture, and up-gradation. This increases the stickiness of the tenant and increases the value of the property over time.
  • Commercial real estate has an attractive return profile for investors - individuals can earn 8%-10% yields from rental income and benefit from additional annual capital appreciation (17-25% IRR). This makes the proposition a lucrative investment avenue to supplement one's fixed-income portfolio. Over the last four/five years, the average rental yield has been between 8-10%, nearly double that of FD returns, which makes it an interesting option for investors looking for additional sources of interest and security on their investments.

Unlike speculative investments, Commercial real estate is a hard asset and hence serves as underlying collateral. This provides downside protection and capital preservation to investors. Traditionally, Hard assets have also been used by investors as a hedge against inflation. With the current increasing inflationary pressures, the traction towards CRE has significantly increased.

What is Driving Commercial Real Estate and The fundamentals that do not change in a post covid period?

  • A lot of demand for IT, ITES space comes from US-based MNC tenants. They choose India because rentals start at $1 per square foot on A-grade properties below market rates in the US.
  • Recent developments in India have made it a hub for IT and R&D outsourcing to major multinationals due to its established reputation as an ITES destination with strong demand from MNC tenants looking at low-cost alternatives for their back-office needs. These MNC's further employ large workforces due to the access to affordable and high-quality talent.
  • The rupee has constantly depreciated against the dollar, so their rentals become even cheaper each time the rupee depreciates. Many renowned funds, such as Black Stone, Brookfield, Maple Tree, are venturing into India and contributing significant demand for commercial real estate.
How are Fractional Investments opportunities in Commercial Real Estate Disrupting the investment practices?

Unlike residential properties, the minimum investment size in commercial properties is 30-40 crores, and this can be considered as concentrated risk into one property. The introduction of new platforms like Real Estate Investment Trusts (REIT) and Fractional Ownership Platforms that allow smaller investments are starting to gain popularity as they provide more opportunities for diversification while still providing significant returns on capital invested.

With the MYRE platform, one can invest in commercial real estate at a fraction of the cost of owning an institutional-grade property. All this with regular monthly rental income and appreciation potential.

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