13 Nov, 2017
The concept of rental yield is fast catching the imagination of investors in India, especially those in the metros. Investors invest in a property with a view to renting it out, so as to earn a fixed income. For retail investors, it is largely confined to residential properties, given their low investment capacity.
It runs with the weather as high interest rates and exorbitant prices deter them from investing as they result in less annual yield.
But UHNIs (ultra high net worth individuals) are transacting in commercial properties which are still in demand and offer high annual rental yield. There is a healthy demand from corporate from the IT and BFSI segments, which en masse account for 60-70% of the total demand. While residential properties give 3-6% as rental yield, commercial properties offer a high rental yield in the range of 9% to 15%.
Pre-Leased Commercial Properties command high yields
There is no doubt that real estate holds the greatest attraction for UHNIs. Most investments happen in properties, say a pocket of land, commercial properties like readily available offices or industrial warehouses. UHNIs, say with a net worth ranging from Rs 25 crore to Rs 100 crore and even above, have been mandating wealth management firms or real estate advisors to pick grade 'A'
These pre-leased commercial properties provide fixed income. Here, the aim is to lease out to quality tenants, earn lease income over a 3-5 year period and subsequently exit with a moderate to high capital appreciation.
There are mainly two kinds of commercial properties. The first is the lease-hold, mainly offered by government institutions like MIDC; they are leased to the buyer generally for a period of 99 years, extendable further. You actually buy rights to use the property and not the property per se. In a way, you are buying a property without really owning it. You have limited rights on what to do with the property.
The second is free-hold property - you become the exclusive owner of the property as well as the land on which it is constructed. It gives more right and responsibility to the owner. In India, a majority of the pre-leased commercial transactions happen on free-hold basis.
What decides the rental yield in these properties?
No doubt, the entry price is one of the biggest factors in determining the yield. Lower the price, higher the yield. Another key factor is the quality of tenants. If the tenant is a bank or an insurance firm, mainly PSUs, the property commands a rental yield of 6% to 8%. These tenants stay for a longer period and the property is less prone to hopping; hence, it commands a lower yield.
Commercial properties occupied by multinational companies (MNCs) like foreign banks, investment banks, etc, or domestic firms like BPOs, IT/ITeS units as tenants generate high rental yields, say in the range of 8% to 12%. So, the question arises how a buyer can ascertain if the tenant will stay for a longer period. If the tenant is incurring a substantial expenditure, say to the tune of Rs 2,000 to Rs 4,000 per sq ft on interiors, it can be fairly assumed that they are going to stay for a longer ..
How to calculate the rental yield
The calculation is simple. You are arriving at a price after including the basic price, stamp duty, car parking charges minus security deposit. The annual lease rent is divided by the final price to arrive at a yield. Generally, the lease term happens for a period of three years, which on renewal commands an escalation of 15% in rent. Hence, the rental yield increases progressively every three years.
For eg, a project ABC having a tenant XYZ has a leasable area of 10,000 sqft and is quoting at a rate of Rs 5,000 per sqft. The total cost after factoring in the car parking charges (4 parkings @ Rs 5 lakh each) plus stamp duty (approximately 5%) is Rs 5.46 crore. The security deposit-adjusted outgo is Rs 4.92 crore
The lease rental is Rs 110 per sqft which entails an outflow of property tax of Rs 30 per sqft. Hence, the net rent comes to be Rs 48 lakh per annum and, hence, a rental yield of 9.76%. If the rent escalates at 15% every three years, the yield increases to 11.78% in 4th to 6th year and 14.09% in the 7th to 9th year, considering other prices to remain constant. The above calculated yield does not incorporate the capital price appreciation, which can happen at any rate.
Ways to take exposure
If you have pockets full and belong to the high net worth individuals' category, you can buy a pre-leased commercial property; so, typically, the transaction will range from say, Rs 5 crore to Rs 100 crore or even higher. However, for investors falling in the smaller bracket, say Rs 1 crore, it is best to enter through private equity-run real estate rental funds which open from time to time. They promise to deliver a pre-tax return (including capital appreciation) of 20% to 25% during the course of the fund's tenure.
The ideas look promising but one must check all the factors related to them, including the quality of tenants and their likely period of stay. One should also check the vicinity and all paths approaching the property. Lower the distance from major locations like highways, railway stations, bus stands etc, better rent it commands.
The author is Senior Manager, Motilal Oswal Wealth Management Business