Investing in commercial real estate: Pros, cons and taxation

Commercial real estate is an attractive investment class because of consistent returns, higher rental value, and passive income it offers. CRE has growth potential and provides a steady cash flow in the form of rentals. Investing in commercial real estate (CRE) through fractional ownership provides retail investors with an opportunity to own fractions of an asset and grants them a portion of the ownership. This is the reason why commercial real estate investing is becoming more and more popular among investors. This article is for NRIs who are planning to invest in commercial real estate in India

NRIs who want to invest in commercial real estate in India or ask any question related to the same can schedule a call right away.

Investing in commercial real estate: Pros, cons and tax implications
Investing in commercial real estate

Investing in commercial real estate

Generally, CRE properties are valued above Rs. 20-30 cr. Traditionally CRE investment remained restricted to UHNIs and HNIs due to its huge ticket size. With new business models, such as the Real Estate Investment Trusts (REITs) and fractional ownership, investing in CRE properties has become pocket-friendly and hassle-free.

The average minimum amount required to invest in real estate ranges between Rs. 50 to Rs. 70 lakh depending on the property type and location. Whereas fractional ownership allows investors to buy a share of commercial property with ticket size as low as Rs. 30 lakhs. This is the reason why NRI investors are eyeing commercial real estate in India

Why invest in commercial real estate

Investment in commercial real estate offers certain benefits over other traditional investment options.

  • Real estate is not affected by market fluctuations. As a long-term investment option, it is stable and offers a consistent rate of return.
  • A commercial real estate property in a major urban market can offer much higher returns because it is rented by a niche segment of tenants, which also assures that renewal of investment keeps giving returns as a passive income.

Benefits of investing in commercial real estate properties 

  • Stable source of high rental income: Commercial properties offer an average rental yield of 8-11% while the average rental income from residential properties ranges between 1-2%, i.e. 4 times lower yield. Depending on the area, the earning potential for investment in CRE is much more. 
  • Long-term commitments: Commercial properties are usually leased for 10 to 20 years, with the possibility of subsequent renewal. Moreover, lease agreements come with a clause of yearly appreciation of the rental value. So, the owner of the commercial property has an assurance of regular and consistent returns. 
  • Professional deals: Commercial real estate tenants are generally businesses with professional track records. Dealing with corporate tenants is always hassle-free and generally there is no need to chase them for rent. 
  • No furnishing cost: One of the most attractive features of investing in commercial properties is zero furnishing cost of the property. If you hand over the property to corporate tenants, they furnish the property as per their own requirements and taste. This is because branding is essential in a commercial space. Also, corporate clients have their guidelines to set up a proper infrastructure at the property they occupy. 
  • Appreciation value: As compared to other property types, CRE provides stellar appreciation over time. What’s more, if you invest in a premium commercial property through fractional ownership or REITs, it may provide higher returns with much lower and pocket-friendly investment.   
  • Free from market fluctuations: Income from traditional investment options tends to become positive or negative depending on fluctuations in the financial markets. On the other hand, investment in commercial real estate is not affected by performance of any other source of investment, because it has no relation with any changes in the stock or bond markets.
  • Tangible asset: Real estate is considered as a more physical and tangible asset because you can see it and touch it. Investors can visit a property to get more insights into its size, location, condition, appearance, and many other features that may play a key role in its earnings. Whereas, stocks, bonds, mutual funds, etc. may not look appealing for such investors, because you can’t see them. 

How to invest in commercial real estate

Because of the high cost of investment, investing in a commercial real estate property is not easy for individual investors. Therefore, fractional ownership or investment via real estate investment trusts (REITs) are the favoured methods investing in CRE. 

Fractional ownership: Like minded investors can pool investment amounts to buy an expensive asset, i.e. commercial property. It reduces a load of entry into CRE by cutting down the ticket size. The minimum ticket size stays within Rs. 25 to Rs. 30 lakh. Depending on the funds, an investor can own a part of the title, and returns from rent are paid proportionately to each investor. 

REITs: These are like mutual funds. Fund managers manage a REIT, and the contribution of investors forms a part of the investment pool that is divided across multiple assets. The returns from all these assets are added and distributed to the investors in proportion to their contribution towards the REIT fund. 

Cons of investing in commercial real estate

  • High ticket size: Generally, commercial properties are valued at Rs. 25 to 30 cr, and the minimum investment in CRE is typically beyond the reach of a retail investor. However, with fractional ownership, now you can start investing with Rs. 30 lakh onwards.
  • Complex asset management: CRE tenants are corporates and not individuals, which requires smooth end-to-end asset management. Retail investors usually lack professional expertise for managing complex commercial assets. 
  • Difficult entry: Because complex legalities, extensive research required and limited market opportunities, investing in this type of asset can be challenging for a naive retail investor.
  • Selection of property: Finding the right property and geographical location needs due diligence and market knowledge. An individual investor may therefore find it extremely difficult to invest in commercial properties due to lack of market knowledge and other resources. 

What is commercial property?

Commercial real estate includes a variety of asset types and they vary in performance and returns. CRE is typically classified into six main categories:

  • Industrial buildings
  • Office buildings
  • Retail buildings
  • Warehouses and parking lots
  • Apartment buildings
  • Mixed use property types used for a combination of purposes, such as retail, office and apartments

The supply and demand, yield and overall profitability of each asset type greatly vary. Some property types perform better than others based on the supply and demand in the property’s specific location. It is important to identify the asset types that provide higher returns than others or offer greater opportunity in the current economy. 

Commercial real estate was the first to stabilize and gain traction in the second half of the 2021 after the initial shock. Commercial real estate market analysis for 2022 suggests that real estate would be more stable in 2022 as compared to market volatility of 2021, created by the second wave of Covid-19. As per JLL’s report, the office space leasing is likely to hit 30-32 million sq ft, around the average of the last five years. 

That said, investors should carefully examine their investment goals, risk tolerance and timeline for generating profits, before investing. Like other assets, investing in commercial real estate has its pros and cons, and tax implications.

Tax implications on CRE investment

Investment in commercial property through fractional ownership is still in its initial stages, hence there are no specific regulations for this asset class. As per the current income tax regulations, rent received from the CRE property is taxed as income from other sources under the applicable tax slab.

House property bought using a home loan qualifies for tax concessions under Section 24 and Section 80C of the Income Tax Act. NRI investors can get benefits under the Double Taxation Avoidance Agreement (DTAA) signed with the country of their current residence.

So, have you started planning to invest in commercial real estate in India and make changes in your portfolio yet? Whether commercial real estate is a part of your portfolio? 

If you are confused or reluctant about investing in India due to lack of understanding of the Indian market, SBNRI will help you build a stable portfolio in an easy way.

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