Evaluating a Commercial Real Estate Investment

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The pandemic has enforced better financial decision making, especially how to invest wisely. So, how does one invest in a pandemic proof asset class that offers stable rental income and provide long term capital appreciation? If you follow principles of long-term investing, Commercial Real Estate (CRE) is one such asset class that offers high annualized returns closer to stocks and with annual yields (through rental income) higher than debt investments in corporate bonds which makes it an attractive investment for the retail investor. More and more people have now realized the significance of investing in commercial real estate and is getting widely accessible  through fractional  platforms such as Restack.  It’s transparent that real estate investment returns are rewarding, but it is important to understand that choosing a CRE investment is different from picking a stock or fixed income security.

When considering investing in CRE, there are key fundamentals to evaluating the property such as:

1. Location of the property

Location is paramount for any real estate investment and drives  rental values for a CRE property and appreciation.

A key measure is vacancy rates, locations with lower vacancy rates can fetch higher returns from rents and capital appreciation.

Another is the supply within the market. A massive amount of new construction or developments in a micro-market more than the demand will lead to potential oversupply situation and hence reduction in rents commanded in the future.

2. Developer and Quality of the building

Developer – An advantage of reputed developer is assurance of quality projects delivered on time with proper sanctions and title.

Quality of the building -Technical specifications of the building include floor to ceiling height, efficiency and car parks ratio.

  • Efficiency is defined as % of the carpet area to the leasable area of the premise. Higher efficiency indicates a higher enclosed usable space for the lessee and is more preferred.
  • Car park ratio is the number of car parks for every sq. ft of leasable area. 1 for around 750 sq. ft of leasable area is an acceptable norm for occupiers.

3. Quality of Tenant

It is extremely important to understand the quality of the tenant, whether it is an MNC, rated or listed. The grade of the tenant will ensure certainty of the rents and will ensure compliance as per agreed terms of the executed lease deed. This becomes very important in uncertain market conditions (like the pandemic), when Grade A tenants  have continued to pay rent  in line with agreed lease terms.

4. Lease deed terms

Following are the common terms in a Lease deed agreement.

  • Lease period or Lease term is the term for which the lease is granted and is typically of 3 or 5 years, with renewal terms for an equivalent period.
  • Lock-in period is the period within the lease period, during which the tenant cannot vacate the property or would have to pay the rent for the balance lock-in period in case they vacate (depending on the lease terms agreed in the lease deed).
  • Warm shell vs Fitted out rent. It is important to understand whether the property fit outs (furniture, fixtures, office cubicles, carpeting etc.) have been paid for by the property owner or lessee. If the fit outs have been paid for and owned by the lessee, in which case rent paid for the premise is warm shell, it increases the stickiness of the lessee on the particular property, considering their capital investment in fit outs on the property. This ensures greater stability of future rents, including greater probability of lease renewal by the existing lessee.
  • Mark to market potential. Rent in INR PSF for the particular property is bench marked with similar grade properties in the micro-market. A lower rent would ensure a potential upside in rent on renewal of lease or re-leasing in the future thereby increasing the potential returns from the property.

Understanding and analyzing the above points before investing will help you in evaluating a rent-generating CRE investment. Apart from these Key metrics such as Annualised returns (IRR), Gross Yield and Investment Multiple help in understanding the investment returns and risks.

Investing in commercial real estate doesn’t have to be as difficult as it may appear. Restack provides professionally vetted investment properties using comprehensive data analytical tools to evaluate your investments based on above fundamentals.

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