As the number of novice investors is increasing day by day, the world of investment is getting wider. Apart from the stock market, and mutual funds, in the past few years, real estate investment has also become a hot topic. Well, it is just an umbrella term that includes various elements of the market. On the contrary, there is a large number of investors who are skeptical about commercial property investment.
Commercial Real Estate investment is a different pool altogether. However, it may look complicated on the surface, an investor can gain high profits once they know how it works and the benefits that come with it. As far as the question - is commercial property investment only for big investors? - is concerned, the answer is NO! Anyone can try their luck in commercial real estate (CRE) investment. There are several factors that an investor needs to consider before planning to start investing in CRE.
With that being said, this comprehensive guide will round up a few important aspects of CRE and how a beginner can start investing in it. The guide will briefly list the pros and cons of commercial property investment as well. So, let's start from the basics!
Basics of Commercial Real Estate
Commercial real estate, often abbreviated as CRE, is a property that is used explicitly for business or workplace purposes. In short, commercial real estate is a property that has the potential to generate profit through capital gain or rental income. Commercial real estate is a broader term that includes office space, industrial properties, multi-family residential rental buildings containing more than five units, and retail spaces.
Commercial real estate is commonly divided into eight broad categories. The brief of each is as the following:
- Office space: Office spaces include all office buildings with workspaces that are available for rent for different businesses to operate.
- Industrial space: Industrial real estate is used for the purpose of industry, including manufacturing, light assembly, bulk warehouses, and flex spaces that can incorporate industrial space with office space.
- Multifamily complexes: Multifamily properties are residential rental properties with more than five units. They are considered commercial spaces because they generate rental income for the property owner.
- Retail spaces: As the name suggests, retail properties are any buildings used for retail purposes; from single storefronts to strip malls and shopping centers.
- Hotels: Hotels are divided into three different categories that are full-service hotels, multi-room hotels, and limited-service hotels.
- Mixed-use properties: Mixed-use properties are typically any possible combination of the above-listed categories. Multi-family apartment buildings with retail spaces on the ground floor are a common example of such commercial properties.
- Land: Land includes farmland, agricultural real estate, vacant land, or brownfield land that was formerly used for industrial or commercial purposes.
- Special-purpose: Special-purpose real estate encloses commercial properties such as amusement parks, theaters, zoos, parking lots.
Pros of CRE
- High Rental Yields:
Interestingly, this is one of the biggest plus points of CRE investment. The average rental yield of commercial property falls anywhere between 9% to 12%, though it depends on the type of property. The rental yield is a fundamental parameter to find out whether you are buying at the right location and at the right price or not.
- Durable and Assured Returns:
Usually, the lease agreements for commercial property are for the long term; a lease is signed for a minimum of 5 years. Thus, the owner is guaranteed consistent returns, unlike residential property. In addition, often the lease agreement carries a clause of annual increase irrespective of market conditions.
Cons of CRE
- Tedious Buying Process
Commercial property purchase requires thorough planning and very detailed research compared to residential property. Any misjudgment can be fatal for commercial property investment. The buying process is a bit complex. In a nutshell, commercial property investment demands keen insight as the future growth potential of the area decides the future returns.
- No Tax Benefits
An investor will not get any tax benefit for the purchase of commercial property on a loan, unlike a home loan. The tax benefit reduces the overall cost of borrowing. Thus, it is one of the crucial reasons why investors often think twice before investing in commercial property.
As there are no tax benefits on CRE, the investors often prefer to pick residential properties. However, rather than only sticking to this point, you should consider the other essential aspects of investing in real estate. For that, novice investors need to understand the difference between commercial real estate and residential real estate.
Difference between CRE and RRE
- Location
as stated earlier, the valuation of commercial property is highly dependent on Location. It is more critical for Commercial property than residential property.
- Return On Investment (ROI)
In terms of Return of Investment among Commercial properties vs Residential Properties, the latter is the clear winner. Commercial Property has the potential to deliver an annual yield of 9%-12% in India, whereas, Residential Property cannot yield more than 4%.
- Cost
Considering the initial cost of investment, residential property is cheaper compared to commercial properties. Since there are no tax benefits available on loans for commercial properties, residential property has an advantage on this parameter.
Though the initial investment demands a lump sum amount, anyone can invest in the commercial property investment. There are various methods available in the market that can provide great help to retail investors. Among many others, the most favored method of investing in commercial real estate is via investing in REITs or fractional ownership.
- REITs: REITs are quite similar to what mutual funds are. Fund managers manage a REIT, and the investment, from various individual investors, forms a part of the investment pool that is divided across multiple assets. Then, these assets are chosen by the fund managers on the basis of their historic performance and the market dynamics. The returns from all the assets are allied and distributed to investors based on their investment in the REIT fund.
- Fractional ownership: Interestingly, this method helps get like-minded investors to pool their investment amounts into owning an asset. According to their risk appetite and funds, individual retail investors can own one or more fractions of an asset.
The commercial property investment is a high-adrenaline, high-returns game, however, it is strongly recommended to thoroughly research before diving into it. Once your vision is clear, you can find some of the best commercial properties that are available for investment across India on PropReturns, an online platform created with data and backed up with analysis.