• Fri. Dec 9th, 2022

Investing in commercial real estate: pros and cons, tax implications explained

ByWillie M. Evans

Nov 12, 2021

With products like condominiums and REITs, investing in commercial real estate (CRE) properties has become economical and less cumbersome. The CRE can provide regular cash in the form of rents. However, experts advise investors to first carefully consider their financial health, investment objectives, ability to bear risk and timing of profit generation.

CRE properties are valued at 25-30 crore and up. Traditionally, investment in CRE has remained limited to UHNIs and HNIs due to the exorbitant size of the ticket. However, with new business models such as co-ownership and REITs, CRE as an asset class has become widely democratized. While the average minimum amount of capital required to invest in a residential property ranges between Rs. 50-70 lakh and the amount may vary depending on the location of the property, joint ownership allows owners to own part of the property commercial with a ticket as low as 25 lakhs.

So, is CRE a better investment than residential real estate? According to Sudarshan Lodha, CEO and co-founder of Strata, there is no simple one-word answer to this. “While profitability is much higher in commercial real estate, entering the CRE market as an individual investor is difficult. Legal complications, domain knowledge, financial components are various obstacles that stand in the way of retail investors. However, they can now be resolved by opting for REITs or fractional ownership,” Lodha told FE Online.

“Having witnessed the growing demand for commercial real estate and a positive future chart, I would advise investors considering a second home from an investment perspective to instead consider investing in commercial real estate which will offer much better returns. Also, the main reason to prefer commercial real estate over its residential counterparts is the higher rental value. Commercial real estate offers up to 3 times the yield of that of residential properties,” a- he added.

Average returns over the past 5 years

Rental yields in the case of residential real estate are around 1-2% while in CRE they are 8-12%. Real estate returns have been consistent over the past decade and may continue to behave similarly over the next few years.

“The rental yield in the case of RRE is around 1-2% whereas in CRE it is 8-12%. With the growing demand for commercial space, the demand for CRE is also expected to accelerate in Tier II cities,” Lodha said.

Advantages and disadvantages of investing in commercial real estate

CRE includes a wide variety of potential assets such as warehouses, manufacturing units, retail spaces, parking lots, schools, shopping centers and cinemas to name a few. According to Lodha, here are some pros and cons of investing in CRE

Advantages

Steady source of high rental income: The average rental income from residential real estate is 1-2% while that from commercial real estate peaks at a staggering 8-12% offering a 3x higher return.

Professionalism: CRE tenants generally have established businesses and professional behavior can therefore be assured.

Long-term commitments: Commercial tenant lease terms are typically between 10 and 20 years, providing investors with a secure and stable source of income on their investment.

Appreciation value: Commercial real estate offers excellent appreciation over a longer period of time compared to other types of properties. Additionally, investing in high-end commercial property through REITs or condominiums can offer attractive returns with a much lower and more affordable investment.

The inconvenients

High ticket size: Valued at 25-30 crores and above, the minimum investment required in CRE is usually exorbitant and therefore beyond the reach of a retail investor.

Asset Management: Investing is not just about putting your money in or owning a particular asset, but also about ensuring smooth end-to-end asset management, including tenants. In the case of CRE, the tenants are companies and not individuals, which makes asset management more complex because individual investors generally lack the professional expertise to manage commercial assets.

Difficult entry: Investing in CRE can be difficult for a naïve solo investor due to complex legalities and limited market opportunities.

Choosing the Right Property: Choosing the right property and geographic location requires extensive research and in-depth knowledge of the market. A retail investor may therefore find it extremely difficult to invest in CRE due to a lack of adequate expertise and market knowledge.

Tax implications

Usually in commercial real estate, for investors in accordance with applicable income tax regulations, rents received from the property are taxed under “income from other sources” under the tax slab applies.

“Despite its growing popularity among its investors, co-ownership of commercial real estate is still in its infancy, so there are no established tax regulations for this asset class,” Lodha said.

Ownership of the house taken out under a home loan qualifies for tax relief under Section 24 and Section 80C of the Income Tax Act. NRIs may explore benefits under the Double Taxation Avoidance Agreement (“DTAA”) with the respective country, subject to the availability of the Tax Residency Certificate (“TRC”).