Real estate investment has always been considered a lucrative option the world over. Apart from gold, bonds and stocks, residential real estate occupies a prime position on most investors’ list. In developing countries like India, the steady rise in land prices and property rentals, coupled with economic growth, has led investors to diversify their portfolio. Investors today are looking at including more than residential investments, thus veering towards commercial real estate (CRE) investment.
Before getting into what commercial property investment scene in India is, it is important to understand how residential investments differ from commercial investments.
The key differences between residential and commercial real estate are:
- CRE investments yield much higher income per square foot when compared to residential projects. On an average, the rental yield for a commercial property is around 8-11% per annum while average rental yield for residential property is not beyond 2-4% in India.
- CRE lease periods are generally longer than residential real estate, and its investments and cash flows are stable and regular, thereby ensuring steady monthly income for the investor.
- Moreover, owing to increasing demand for quality office spaces in metro cities, the vacancy period for CRE is considerably lower than residential real estate.
- The focus in CRE investment is purely transactional, whereas residential investments include an element of emotional investment as well.
- Down payments and interest rates are much higher on CRE loans than residential property loans that are procured through financial institutions.
Thus, these points clearly denote that CRE investments have a definite financial end goal, and the returns on such investments can be expected to be relatively high. However, while owning physical assets is one way to generate income, most people do not possess the expertise or finance to invest in commercial projects. These conditions along with the present market situation has led to the timely introduction of Real Estate Investment Trusts (REITs). The introduction of REITs in India is projected to provide a major boost to the CRE in the country. As per industry reports on the sector, it was indicated that $121 billion or 1.73 billion sq. ft. of occupied commercial real estate across office, retail and warehouse segments could potentially benefit from the REIT opportunity.
The REITfication process
REIT is based on the mutual funds model, where investors can invest as little as Rs 2 lakhs in income-generating real estate assets. A trust comprising of no less than 100 shareholders is listed in the stock exchange and individuals can trade for units of the trust. According to a PwC report, USA, Australia, France, Japan and the UK are the top five markets for REITs in the world.
In India, REITs are expected to liberate the economy and enthuse more participation from small investors who would be empowered to engage with asset classes that are otherwise out of their reach.
REITs in India
In India, the focus of REITs will be on an equity linked REIT model, where its returns will be derived mainly from rental income or capital gains from real estate. A REIT will be registered through an IPO or an initial public offering where units will be traded on the stock market as securities. The Stock Exchange Board of India (SEBI) has mandated that the minimum asset size be Rs 500 Cr and the offering is limited to Rs 250 Cr. People may buy these units from primary and secondary markets.
Why are REITs attractive?
A diversified investment plan and one that involves commercial real estate without the risk of owning the physical asset is certainly the chief selling point of REITs. Today, the Indian investor is smarter and more evolved, seeking risk-free investment opportunities, and REITs offer just that. It is mandated that 90% of the income generated has to be distributed among shareholders ensuring a steady flow of returns.
The future of REITs in India
REITs hold immense potential in India and this has been vetted by some of the country’s largest office owners and fund houses. Embassy Office Parks Real Estate Investment Trust became the first registered trust with SEBI, which was soon followed by Blackstone, DLF and K Raheja.
The future of CRE investments undoubtedly lies in REITs. Apart from small investors, RBI has also given its approval to banks to invest in REITs, to the tune of 20 percent of their net owned funds or NOF, much like VC or equity-linked mutual funds. Although a lot of churn is expected in the real estate market this year owing to the implementation of various recent policy changes, we believe that when REITs become commonplace it will enhance transparency and governance standards as well as bring in liquidity and increase capital flow, ensuring rapid development of the country.