Although homeownership sentiment is a prevalent theme in investment spheres, it is essential to understand that residential real estate as an investment has its own risks. Many direct investors have been drawn to residential real estate in the current market relative to commercial real estate.
Last year, as India stepped into its second and third lockdowns, the uncertainty in equity markets and the low returns in the debt market has increasingly driven investors to consider alternative investment options. The Indian real estate sector attracted USD 5 billion in institutional investments in 2020, equivalent to 93 percent of transactions recorded in the year before. Real estate has been considered the best hedge against inflation. Due to the recent upward pressure on the inflation rate, the current scenario does arguably present an opportune time to reallocate one's portfolio to hard assets such as real estate.
Traditionally, most retail investors have been drawn to residential real estate due to the ease of access relative to commercial real estate.
Investing in residential real estate instruments
Some challenges in real estate investment include lower rental yields close to two percent, tenancy issues (identification, stability, management), and property management or upkeep. For an investor, these challenges often amount to an unanticipated mental load and unwanted burden.
For investors who wish to invest via this route, they should be aware of the over-supply of residential real estate projects. A report by Khaitan & Co and Knight Frank has analysed that there were over 11.09 million urban vacant houses in 2019.
Investing in commercial real estate instruments
Commercial real estate (CRE) has become the preferred asset class for institutional investors and HNIs due to a stable monthly rental income from 8-10 percent rental yields and annual capital appreciation close to 15-25 percent internal rate of return (IRR). Such investors have been increasing their allocations towards the real estate sector with over 26 percent of Indian high net-worth individuals (HNI) investments in 2019 flowing into the real estate sector, according to a report by JLL India. Due to the spread between the residential rental yield of nearly two percent and a commercial rental yield of about nine percent, retail investors have started recognising the benefits of CRE.
The traditional barriers for entry into commercial real estate for retail investors include:
- High ticket size- Most A-grade developments tenanted by MNC firms would cost an investor upwards of Rs 25 crore, limiting the access to HNIs and funds.
- Management and maintenance- CRE requires active property management, asset selection, tenant management, legal due diligence, etc. Often this has been a deterrent as most investors do not have the time or expertise to manage a CRE asset.
- Access- CRE in India is a relationship-based investment model, and often, individuals cannot differentiate between lucrative and distressed deals.
With the introduction of fractional ownership in CRE, many traditional barriers to entry for retail investors have been eroded. Retail investors can now participate in institutional-grade opportunities at a fraction of the cost via such platforms.
As the industry draws more attention to itself with rewarding returns, it becomes imperative that investors are made aware of the avenues of investment via the real estate sector.
Stable monthly rentals secured by long-term registered lease agreements with MNC tenants make this asset class a compelling fixed income investment option for investors. Annual capital appreciation of key properties is driven by the rampant growth and development of the IT/ITeS office sector combined with increased demand by MNC tenants for office space.
Owing to such strong fundamentals of the office market in India, the office sector has now become the talk of the town. Since 2011, the sector has sourced USD 15.4 billion of equity investments and, during YTD 2020, has attracted an 81 percent share of total PE investments.
The world assumed that work from home would hit the CRE market, but as we slowly crawl back to normalcy at work, we see the trend reversing. According to a report by Knight Frank on the office market, around 90 percent of the employees in the IT/ITeS sector miss their office environment. With IT enterprises facing security concerns, a trade-off between one percent cost savings for IT firms and the real estate investment in the future seems likely.
Investors must be careful of half-baked knowledge-driven decisions and must thoroughly analyse the properties they invest in. Strong fundamentals like Grade-A properties, chosen with strategic growth in mind and a sound investment partner, will help the investors generate wealth throughout their investment.
Prominent successful commercial real estate properties closing in a few days have shown the asset class' scope of investment and returns. The sector is expected to predict growth and development with vaccines rolling out and offices re-opening. Despite the global pandemic and its uncertainties, the market fundamentals of the real estate sector continue to be strong and would be seeing strong growth in the upcoming months.