These days, everyone seems to be only speaking about residential real estate as an asset class. Conversations around it seem to be everywhere – in media interviews, social media discussions and full page ads. There is huge FOMO around this space but most people have got one one part of this story right and the other part wrong.
Real estate is a lucrative asset class. Not so much residential real estate but actually commercial real estate. Residential real estate, despite its associated hype, has a lot of issues. Rental yields are low (around 2 – 4 per cent), only the premium section is growing while the rest isn’t and there are always issues with liquidity and ticket size.
Commercial real estate is a different conversation altogether. Let us explore this.
One of the most lucrative asset classes in the days to come
Commercial real estate – think of offices, e-com warehouses, flexible workspaces, data centers, etc has a very attractive growth story over the next few years. According to Mordor intelligence, the commercial real estate market in India is estimated to be at $ 49.3 billion in 2025 and is expected to grow at a CAGR of 21 per cent to reach a size of $ 128.4 by 2030. This will be driven by a growing economy, rise of e-commerce associated double digit growth and even the incredible rise of global capability centers in India.
But the asset class is very rewarding in other aspects too. Due to its commercial nature, leases to tenants tend to have stable cash flows for a longer period of time and has automatic rental escalations baked in. As a result, the rental yields for commercial real estate are in the range of 7 – 10 per cent compared to 2 – 4 per cent for residential real estate. Not to forget, there is capital appreciation for commercial real estate when it is located at the right locations.
REITs and Fractional Real Estate are emerging as key investment channels
A Kotak Private Banking Survey titled ‘The Top of the Pyramid’ launched in May suggests that India’s ultra-rich holds 29 per cent of their portfolios in real estate and within that, 45 per cent of respondents named commercial assets as their most preferred real estate class versus 33 per cent who favored homes and apartments.
As a retail investor, investing via Real Estate Investment Trusts (REITS) is the most obvious channel as ticket sizes can be as low as Rs. 10,000. REITs operate by pooling funds from multiple investors to acquire and manage income generating commercial properties and then distributing the rental income among investors in proportion to their holdings. By regulation, REITs must distribute at least 90% of their net distributable income to unit holders making this a strong option for those seeking steady returns.
In India, there are a few prominent REITs – Embassy Office Parks REIT, Mindspace Business Parks REIT, Brookfield India Real Estate Trust and Nexus Select Trust. The first three have been around for around 5 – 7 years and have generated a dividend yield of 6 – 8 per cent and a capital gain of 10 -14 per cent indicating a total CAGR return of 16 – 20 per cent. From a tax perspective, capital gains are treated as long term capital gains for units held more than 12 months. Dividend income can be taxable at the SPV level or at the hands of the retail investor.
An emerging channel is Fractional Real Estate. In this asset class, you can buy a portion of a property through a Special Purpose Vehicle. It is largely a private platform (unlike REIT) and needs a higher minimum investment of Rs. 10 lakhs. It has been historically unregulated but is slowly moving under SEBI rules. Due to its private nature and high ticket size, it may have concerns around liquidity and resale.
Not to forget that any asset class has a few risk drivers. Commercial real estate has fundamental risks — there can be vacancy issues, tenant issues and even maintenance issues. And tariff wars can affect the growth prospects on commercial real estate (e.g., global capability centers).
Retail investors should consider investing 10 per cent of their portfolio
Even as a retail investor, it is prudent to invest upto 10% of their portfolio in commercial real estate via REITs. As an asset class, it is likely to be very lucrative and more stable that other asset classes.
This is the real estate class that actually matters!
Disclaimer
Views expressed above are the author’s own.
END OF ARTICLE