Investing in the office market

Low residential yields have pushed commercial real estate investors into promising new avenues of profit and stability

Low residential yields have pushed commercial real estate investors into promising new avenues of profit and stability

Investors are once again attracted to the real estate sector in India. An attractive capital gain potential, recurring rental income and the tangible nature of the sector have generated renewed interest from investors. Meanwhile, crypto and other financial markets have also weakened after a recent bull run, which further diverts investment into the real estate sector.

When it comes to real estate investing, as a general rule, commercial real estate is preferred over the residential market, as the former is a better option for generating rental returns. Within the commercial segment, offices are again becoming the favourites.

Go forward

As the crisis has subsided and a more favorable growth environment has taken over, demand for office space is growing rapidly in most major cities. Most organizations aggressively implement back-to-office programs, resulting in a significant increase in office uptake. This also translates into increased investor confidence in the asset class.

Another advantage for investors is the low prices of office shares. In 2021, according to the CBRE South Asia report, total rental business in India stood at 41 million square feet, growing by 16%. However, the same year, a total of ~50 million square feet. new offices entered the market, bringing the total cumulative supply to 773 million square feet. An oversupply in the market would be a blessing in disguise for savvy investors as they can acquire the asset at affordable prices.

In India, offices offer much higher rental yields. Many factors dictate returns, including tenant profile, macroeconomic conditions, market conditions and more. However, if invested with caution, offices can easily yield returns in the 8-10% range.

By contrast, residential yields have been historically low in India. In most metros, the yield varies between 2 and 4% on the housing market. Another category that can yield an attractive return could be retail. However, retail in India is still under pressure from low occupancy.

According to Knight Frank research, average vacancy rates in shopping centers are north of 19%. The slowdown in demand in the retail segment is not only explained by the pandemic, but also by poor asset utilization. Industrial assets, logistics and warehouses have also seen renewed investor interest in recent years. These assets can show returns of around 9 to 10%.

However, finding tenants is tedious. In addition, many maintenance activities are required for these asset classes. This further makes desks one of the safest and most suitable assets to bet on.

The desk is also a great asset for diversifying and spreading portfolio risk. While financial instruments are erratic, real estate assets such as the residential market offer suboptimal returns. On the other hand, investing in the office market is not only safe, but can also generate simultaneous rental income. Meanwhile, offices can also give a decent return on capital, provided they are held for the medium to long term. (On average, investing in an office asset requires a holding period of about five years.) For the foreseeable future, offices will continue to grow in the country.

After the virus softened the stance of the economy over the past two years, the economy is back on solid footing again. It is expected to grow by over 8% in the current fiscal year. At the same time, the growth of commercial activities will continue to guide the absorption of offices.

The author is partner, RPS Group.

Jose C. Birney