Tips to Invest in Office Space
Amar is a CFA Charterholder and CFP, having over 20 years of experience in IT and Financial Services. He is very passionate about spreading financial literacy and has authored four bestselling books on Personal Finance.
28 Jul, 2017
Real estate as a sector has seen its fair share of ups and downs. Currently, while the residential segment is coated in dejection, demand has picked up considerably in the office segment. As per a report by Cushman and Wakefield, a global real estate consultancy, absorption of grade A office space is likely to amount to 158 million square feet between 2015 and 2019 in India’s top eight cities. As a deep pocketed investor, one can take advantage of the growing demand for office space.
Any investment made, needs to be done with prior research and understanding. Here are a few tips to help you make sound and well-rounded decisions prior to delving into office space investments.
<h(3)>Weigh the pros and cons
- Before investing in commercial property, one must weigh its pros as against that of investing in residential property. On a positive note, investing in a commercial property is likely to earn a higher rental yield of around 8%. In comparison, the rental yield on residential property is a meagre 2-3%. In case you are still employed and purchase a commercial property, you can give it out on rent for the time being and make use of it as a base when you decide to work independently.
- As with anything, there are cons to the situation that need to be considered. For one, capital appreciation of residential properties is likely to be higher than that of commercial properties. Acquiring a loan for commercial space is a lot more difficult than acquiring it for a residence. The rate of interest is likely to be higher too. Ticket sizes tend to be higher in the commercial segment, calling for deeper pockets. In the event that the economy witnesses a downturn, demand for office space could shrink; the place you have invested for so long in may lie empty and you may have to settle for a lower rent or may find it difficult to raise the rent when the lease is up for renewal.
<h(3)>Choose the right area and project
- Location matters. The intended office space must be in an area that’s on the brink of economic growth, whereby newer companies will look to set up their offices. This ensures that the demand for office space will always be buoyant. Get an estimate of the amount of office space that will be developed in the locality. If a lot of space is likely to be developed, demanding a higher rent would be difficult for you due to the supply glut.
- Infrastructure is of great importance too. Connectivity to highways, railway stations is important in terms of entry and exit points. Roads and drainage systems should be under constant maintenance to avoid traffic jams, especially during the rainy season.
<h(3)>Go with the right builder
- Picking the right developer ensures that the quality of buildings being developed are up to par. Before zeroing in on a developer, meet up with some investors from his earlier projects and make enquires about his service, quality and delivery time. Maintenance post construction is also a crucial aspect to consider.
<h(3)>Invest at the right stage
- Investing in office property can occur at three stages. This isn’t a successive movement; investments can be made in any of the following three stages.
- If you invest at a time when the building is under construction, you can buy it at the lowest price. Buying at this stage offers the potential to earn the highest capital appreciation. However, investing at this stage also offers the highest risk because the developer might delay the project or not deliver on all fronts as promised. To mitigate this risk, it is best to invest with a reputed developer.
- Investing in a completed project lowers both, the risk and the potential for capital appreciation. The only risks at this point are delays in finding a tenant or having to settle for lower rentals than what you had anticipated.
- The risk you face is the lowest when you invest in a building that is already completed and occupied. However, a large portion of the capital appreciation expected from the project is likely to have already taken place. Thus, despite paying a high price, you will have to be content only with rental income.
- Conservative investors should invest at the second or third stage.
<h(3)>Avoid assured-return schemes
- Schemes wherein the developer promises to pay a return of 12-13% on your investment, are quite common in the office sector. Banks generally avoid lending to developers, especially smaller ones. If they do, a high rate of interest is demanded. By offering an assured return, the developer is basically attempting to raise development finance from the buyer.
- According to experts, an offer of an assured return scheme is a sign of financial distress. The builder’s financial health must thus be looked at thoroughly because the likelihood of delay in delivery of project is higher in case of a developer who is financially stressed.
- Small and first-time developers should be avoided when the real estate market is slowing down.
Sometimes when a developer offers an assured return scheme, a higher price is charged than that of similar projects in the area. Essentially, he is giving you back the buyer their own money. Thus, a thorough price comparison must be done prior to investing in any scheme.
<h(3)>Avoid investing in pre- and soft launches
- Soft launches for projects are a common feature at this point, the developer might still be in the process of acquiring land. Once land is acquired, its usage needs to be changed, licenses and clearances need to be received. This process is full of hurdles that need to be crossed. Therefore, despite whatever discount the builder may be offering at the pre-launch stage, retail investors should avoid investing at this stage.
If due diligence is performed while investing in office property, the investment can yield a good source of regular, passive income for you (an income you don’t have to work for).