As an investor, the best way to understand any kind of investment option varies from individual to individual. Some prefer the practical approach, so they learn from their failures and successes, while some prefer to do in-depth research on any kind of asset they are interested in. The issue with investing in commercial real estate (CRE) is that the first option isn’t advisable. When investment in CRE was limited only to institutional investors, the scope of a retail investor getting into commercial real estate was limited – the primary reason being the massive amounts of funds required. But with REITs, fractional ownership gaining popularity by the day, investment in real estate is within the reach of retail investors looking for steady growth in a stable asset type. As with every other investment option, commercial real estate also comes with its own risks, however negligible they might be, so before beginning to invest in them, one should also take heed in understand how the CRE market works and what pointers to follow when looking at a prospective property for the sake of investment.
The return on investment in commercial real estate relies heavily on three major things – the location of the property, the demand and supply, and the history of the region concerning the asset subclass. Let us do a deep dive on each of those factors –
1. Asset sub class – In commercial real estate, one can choose from options like hospitality, warehousing, industrial and manufacturing spaces, retail, and office spaces. There might be more subclasses if finer details are sought out, but these are the major different categories. Each one of them offers advantages based on your investment goal and tenure of investment.
a. Hospitality segment deals in spaces like hotels, restaurants, inns, and the like. Rental agreements could have a lease tenure of 20 years, although lesser periods can also be agreed upon. This segment of the CRE market probably suffered the most during the COVID-19 pandemic
b. Typically speaking, the longest tenure of leases (15 years or more) often happens in warehousing and industrial & manufacturing spaces. The reasons are primarily owing to the nature of the business itself. Companies that lease such spaces have identified a profitable supply chain route that is economically viable and sustainable. There’s hardly any reason to move from such a location every now and then
c. Retail space if affected by the buyers in and around the region. If there is a good and bustling residential market around, retail spaces can appreciate in a span of a couple of years. Major retail chains can commit to lease tenures of 10 years or more easily, while mall spaces can be leased for 7-8 years at a stretch
d. Office spaces can have shorter or longer tenures based on the tenant and the requirement. If a space is being leased as a major hub, the lease tenures can go up to 10 years, while the general lease term for office spaces is around 5-6 years. Tenants who tend to do their own fittings and customizations generally stick around longer and renew the leases on similar terms on repeat
2. History of the region – Understanding this will take a bit of effort, especially if as an investor you are completely new to a region. Some areas tend to have great response to office spaces, even if they are in a residential area, while industrial and retail spaces normally do not share the same location. A good retail space might not attract as much business in an area where people tend to prefer smaller local businesses. Likewise, as a rule of thumb, having a large Grade A office space in the heart of a residential area might not be a good idea. The market responds differently during different times as well. So, speaking with a seasoned real estate expert before deciding on your investment venture always helps
3. Demand and supply – With the availability of newer, better constructed places, competition increases for rent, and depending on the tenants, switching of properties can also be much more frequent. If there’s an area with a lot of scope for residential buildings and a couple of retail spaces come up, while the investment opportunity is good, you should also keep a tab on how the lease structure is and what kind of tenants are signing up. If the tenants have a steady business model and a history of sticking with their leased spaces, all is good
4. Location – This is by far the most important aspect of investing in CRE. All other factors mentioned before somehow depend in part on this factor. The most risk posed to CRE is through natural calamities. So, areas prone to flooding, earthquakes, cyclones are typically not on the safe list for investment purposes
A lot changed in the commercial real estate market during the past few years of 2019-2021. While some segments of the market underwent stagnation, some others showed growth. The office space market went through some uncertainty during the work from home spell, but things have started to turn up brighter as the days go by. With an expected growth of CAGR 13% during the forecast period of 2022-27, it’s no wonder CRE is one of the best asset classes to start investing in if long-term steady returns are one of your investment goals. And what better way to get started on this than through fractional ownership via Strata?
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