Why to invest in Pre-leased Office Space ?
Investing in office space helps you diversify your real estate portfolio while earning regular rental income.
If you are a savvy investor who wants to diversify his real estate portfolio, office spaces can be a good bet. Investing in offices – one of the two components of commercial real estate, the other being retail – is a good way to earn high rental income and gain from capital appreciation.
In an environment where stock markets are known more for erratic movement than decent returns, real estate investments are considered safer. Among all segments, residential is considered the safest, due to easy-to-understand market dynamics (demand-supply situation). It gives a small rental (2-5% value of the house in a year) and good capital appreciation (generally in double digits).
However, those with adequate experience of investing in residential properties should consider office spaces as well. Offices, or any commercial real estate for that matter, diversify your real estate exposure.
In offices, the rental income is 7-10% of the property’s value in a year, several times more than what you earn from a house. Capital appreciation, however, depends upon the timing of the investment and the state of the economy.
“Capital appreciation may be based more on macroeconomic and investment climate, which may differ from the area’s “Capital appreciation may be based more on macroeconomic and investment climate, which may differ from the area’s
“It’s a good time to buy pure commercial properties. When I say this, I am excluding properties zoned as IT (information technology), ITeS (IT-enabled services) or industrial. Commercial spaces help investors earn better rental yields than houses,” says Raja Kaushal, managing director, Gatere Real Estate and Infrastructure Advisory Services, a real estate brokerage with focus on commercial properties.
But why invest in property? “Real estate investments in India have given superior returns than other assets such as equity and debt over the last five years,” says a report by real estate consultancy Knight Frank India.
“In comparison to an asset such as equity which is dependent upon several factors related to the underlying business like profitability, leverage and corporate governance, real estate investment is based on the underlying asset,” says the report.
Investment in offices has to be managed differently than investment in houses. First, the investment horizon has to be much longer. Second, there’s not much scope for flipping these properties.
“Office investments are typically mid- to long-term, with a horizon of over five years,” says Kumar of DTZ.
Also, generally, office units are bigger than residential spaces. This means a bigger investment.
“Spaces ranging from 10,000 square ft to 30,000 square ft are ideal in the current scenario. If you want to invest in a large office space, you should go for one that can be split into smaller units if you are unable to find a big tenant,” says Kumar.
With an investment of Rs 10-50 crore, you can expect a rental yield of 9-10% per year. A bigger investment (more than Rs 50 crore) can give you the leverage to earn a higher rental yield than this.
Nowadays, you can invest in office space even if your budget is not very big. In Mumbai, the Delhi-National Capital Region (NCR) and Kolkata, there has been a sharp rise in the demand for smaller offices over the last few years.
“It is advisable to go for prime locations and smaller units in the range of 3,000-5,000 square ft. Integrated mixed-use projects (with residential as well as commercial spaces) are likely to give better yields,” says Kaushal of Gatere.
Unlike houses, for which there are first-time buyers even in a bad market, the demand for offices depends upon the performance of the local industry. Each city has its own key economic players, your potential tenants. Before investing, you must understand their requirements. For instance, if information technology companies rule the roost in your city, you would be better off with an office that can accommodate a big workforce that is typical of such companies.
Like in the case of residential properties, you can also invest in a commercial property at the under-construction stage or find a pre-leased and ready office. The latter will save you the trouble of finding a tenant.
“For those investing in small offices, unleased space is not recommended. Under-construction commercial stock is for those who can lease it out,” says Gaurav Kumar, co-head, capital markets (India), CBRE South Asia, a consultancy specialising in commercial realty.
“If the responsibility for leasing does not lie with the developer, the person may have to co-ordinate with other investors in the property to offer larger spaces than one’s own in case strata sale of the property was made to a number of investors,” says Kumar of DTZ. In strata selling, the developer sells in smaller units and not large blocks.
Though office units usually require a big investment, they are easier to manage. One reason for this is that a big amount can be invested in one huge property instead of multiple units (which will be the case in residential properties, where the ticket size is low).
On the flip side, you might face difficulty in leasing the office when a tenant moves out. As a result, the property may stay vacant longer than a residential property.
There are many locations you can explore for investing in offices Some of the top ones recommended by real estate consultants include Delhi-NCR, Mumbai, Bangalore, Pune, Hyderabad and Chennai.
It is one of the most important investment destinations in the country, also the biggest in terms of stock availability (around 110 million square feet at the beginning of 2013). Due to the large supply, it also has a high vacancy level, at present close to 20%, according to Knight Frank.
“In Delhi-NCR, capital values in commercial hubs have remained stable over the last few quarters. Therefore, investing in a pre-leased asset may be the best option, as it will generate revenue from the first day. Investors can also gain from the periodic increase in rentals that can be defined in lease agreements,” says Kumar of DTZ.
If you want to invest in under-construction office stock that is available at a lower price, you can explore properties expected to be delivered in the next twothree years.
“In Delhi-NCR, the peripheral locations of Gurgaon and Noida have consistently performed much better than the central and sub-urban areas. They have accounted for more than 80% uptake since 2009,” says Kumar of DTZ.
“Sohna Road in Gurgaon and Noida-Greater Noida Expressway have emerged as new office hubs and offer good opportunities,” he says.
These peripheral locations provide good Grade-A buildings at a lower cost. Social infrastructure in these areas is also developing rapidly. The Noida-Greater Noida Expressway (Sectors 124-144 of Noida) is an emerging destination for offices.
The country’s financial capital is another big market for office properties. IT/ITeS and BFSI (banking, financial services and insurance) sectors account for more than half the occupied office space.
Between 2008 and 2012, the office stock in Mumbai doubled from 47.4 million square feet to 95.1 million square feet, according to Knight Frank. Vacancy, as a result, went up sharply from 4.3% in 2008 to 23.2% in 2012; rentals fell 10-40% during the period.
“In Mumbai, capital values in most micro markets are at present 10-15% less than the peak touched in 2008-09. In Bandra-Kurla Complex, or BKC, the price was Rs 35,000 per square foot in 2008-09. Now, it is Rs 29,000-30,000 per square foot,” says Kumar. “Capital values have been stagnant for the past few quarters and are expected to remain stable in the short term,” he adds.
Like in most metro cities, people in Mumbai, too, are moving from central locations to emerging areas for cheaper and better (bigger as well) offices.
“Over the last two quarters, off-central business district (CBD) locations such as Lower Parel and secondary business district (SBD) areas such as Andheri-Kurla Road, Goregaon and Kurla have seen a lot of transactions as they offer good connectivity and highquality spaces at much lower prices than CBD and new CBD locations,” says Kumar.
In recent months, several companies have moved from central Mumbai to secondary business centres to cut costs or in search of larger spaces. With companies favouring secondary and peripheral locations, these should be preferred for investments.
“Around 200 acres land is expected to be available around the Mumbai airport for commercial development in the next two-five years. This may be a good opportunity for investors,” says Kumar.
If Mumbai is our financial capital, Bangalore is the country’s IT capital. The city’s office market has so far been driven by demand from IT/ITeS companies. Though a lot of manufacturing, automobile and biotechnology industries are also present in the city, the IT/ITES sector is the dominating force and accounts for 57% of the occupied office space, according to Knight Frank. BFSI and manufacturing account for 18% and 15%, respectively.
At present, the office stock in Bangalore is 99.3 million square ft, of which 86.3 million square ft is occupied. Though the vacancy level is 13%, it has been declining steadily since 2009, when it was 23%. Knight Frank says demand is expected to rise in the coming years and bring the vacancy level down to 12% by 2017. Rentals are expected to remain more or less stable during the period.
“At present, rentals in some sub-markets in Bangalore, including the CBD, are less than in 2007. Looking at the cyclical nature of the real estate business and the supply-demand dynamics, this is a period when rentals are rising, a trend not likely to reverse in the near future,” says Kumar of DTZ.
“This may be a good time to invest in offices in Bangalore due to the potential for capital appreciation, provided the investment is made in the right asset,” he says.
Offices at SBD locations, which include Indiranagar, Koramangala, Airport Road and Old Madras Road, will continue to be popular with companies looking for prime locations close to residential areas, according to Knight Frank India.
Outer Ring Road sub-markets can also be good investment bets as they have seen good investor interest over the past three years. “A number of institutional investments running into several million dollars have been promised by marquee investors such as Blackstone and Mapletree in Outer Ring Road sub-markets,” says Kumar.
At present, there are many properties in the IT/ITeS office hubs of Outer Ring Road and Whitefield. “The outlook in the city looks good as rentals are projected to rise,” says Kumar.
Till a few years ago, Pune was mainly a manufacturing hub, with a lot of auto and ancillary units. Things have changed over the past few years.
Due to its proximity to Mumbai, Pune is now home to many IT/ITeS companies as well. The sector accounted for 75% occupied office space at the end of 2012. Manufacturing occupied 12% while BFSI, consulting, telecom and infrastructure sectors accounted for 11% occupied space.
The growing presence of IT companies is fuelling demand for quality offices. This has led to development of new locations in peripheries and suburbs. Pune is now an important destination on the Indian office market map.
The city has 43.1 million square ft office space, of which 34.2 million square ft is occupied, according to Knight Frank. Though IT/ITeS companies need large offices, there is demand for small office spaces as well.
“There are several small- and medium-sized companies in Pune. Hence, there is demand for both large and small spaces,” says Kumar.
Kalyani Nagar, Airport Road, Vishrantwadi, Kharadi, Yerwada and Baner offer a lot of big and quality spaces. These are well-connected with other parts of the city and have the lowest vacancy rates, two reasons that make them attractive investment destinations.
The demand is expected to grow at 8-14% a year for the next five years. Around 20 million square ft of new space is expected to be occupied over the next five years. The IT/ITeS sector will remain the key demand driver, followed by manufacturing and services sectors. Supply is expected to lag demand, which should push up rentals.
A lot of new supply (9-14 million square ft) is likely to enter the market during 2013 and 2014, which is expected to increase the vacancy level in the short term. However, the level is forecast to decline and stabilise around 20% by 2017.
Political turmoil over creation of the new state of Telangana by dividing Andhra Pradesh has for long been a hindrance to growth of the real estate sector in the state capital. Now, the decision to divide Andhra Pradesh is likely to lead to fresh investments. Another plus is that Hyderabad will be the shared capital of both Telangana and Andhra Pradesh for the next 10 years.
Over the last decade, the state has developed Hyderabad as a technology hub. It has witnessed largescale infrastructure development and rapid growth in locations surrounding the Hitec City, the township at the core of the state’s IT boom. According to Knight Frank data, around three-fourths of occupied office stock is with IT/ITeS companies. Before this, the city’s business landscape was dominated by engineering and trading companies.
The IT/ITeS boom prompted a surge in new real estate projects in 2006 and 2007. However, when these properties became ready, the market slumped due to the global economic crisis of 2008.
“This caused vacancy rates to rise to 20% in 2009. The market has recovered since then in spite of the Telangana movement. The vacancy rate is now at the pre-crisis level of 14%,” says a Knight Frank report. “The city has a stock of 49.1 million square ft, out of which 6.7 million sq ft is vacant,” it says.
With the political agitation for Telangana set to end, the real estate market is expected to become livelier as companies become confident about the political atmosphere and expand. Affordable rentals, ample quality spaces and availability of a big talent pool make the city an attractive destination for the IT/ITeS sector.
“The secondary and peripheral markets of Hyderabad have witnessed higher activity in the last couple of years as compared to the central areas. However, average capital values in these locations are currently lower than the peaks touched in 2011,” says Kumar of DTZ.
Secondary business locations such as the IT hub Hitec City, Kondapur, Madhapur, Manikonda and Kukatpally are expected to give good returns in the next five years.
“SBD office markets of Banjara Hills and Jubilee Hills are preferred markets for investment as they have a lot of mixed-use projects (retail as well as office spaces). The peripheral business district regions of Gachibowli, Kondapur and Kukatpally have a number of options as several developers have launched projects in these areas,” says Kumar.
The capital city of Tamil Nadu is one of the important destinations for the office segment. Like all other major cities, the IT/ITeS sector plays a big role here. However, Chennai is also a hub for automobile, electronics and apparel industries. The city, nicknamed ‘Detroit of India’, is home to a big chunk of the country’s automobile industry. The city’s industrial growth is also aided by two major ports-Chennai Port and Ennore Port- which make it easier to export and import goods.
The growth of manufacturing and IT sectors has given a big push to the office market here. At the start of the year, Chennai had a stock of 49.8 million square ft, according to Knight Frank.
With occupancy at 37.4 million square feet, the vacancy level stood at 25%. It is interesting to note that the vacancy level has moved only slightly from 22% in 2008 to 25% in the end of 2012 despite the doubling of the available office space. Around 25 million square ft office space is expected to get ready over the next five years. However, the vacancy rate is expected to go down significantly.
At present, IT/ITeS, manufacturing and BFSI sectors account for 56%, 20% and 10% of the total occupied space, respectively.
In terms of good returns from your investments in office units, Knight Frank suggests CBD and off-CBD locations (Anna Salai, RK Salai, Nungambakkam, Greams Road, Egmore and T Nagar), SBD (Mt Poonamallee Road, Porur, Guindy and Nandanam), and SBD OMR (Perungudi and Taramani). Interestingly, Chennai is the only city out of the six discussed here where central business locations are expected to beat secondary and peripheral locations in terms of investment returns.
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