Investment in Commercial Real Estate vs Residential Real Estate: A Comparative Analysis of Rental Yields

Indian real estate is once again poised to grow at a rapid scale. It is holding a firm ground, marked by healthy economic sentiments and low-interest rates. Alongside end-user activities, investments are also getting a shot in the arm. 

Meanwhile, the old debate to invest in Commercial Real Estate (CRE) or Residential Real Estate (RRE) is also resurfacing. Both asset class has their pros and cons. There is no standardized set of parameters to compare CRE and RRE. However, CRE outperforms its residential counterparts significantly, if we talk about rental yields. Commercial assets such as offices, retail, warehouses, etc. remain safe assets to bet on, as they can be a source of recurrent rental income. 

The Rental Yields are higher in CRE in India

Globally rental from housing can be a source of smart returns. The downtown area of London can easily give a yield of around 4.5%. Likewise, Dubai and Bangkok can post returns of 5.5% and 5.3% respectively, fostering a conducive environment for better investor participation. 

However, the same perspective does not hold true in the Indian market. In India, the growth in the rental rates has not been in proportion to the growth in property prices. 

Housing yields are around 2-3%. , significantly lower compared to international markets. The rental yields are a little less than 3% in Delhi NCR.  In the Mumbai Metropolitan Region (MMR), it mostly ranges between 2.5-2.7%.  In the South, upcoming IT corridors in Bangalore can yield up to 3.3% (the general average is 2.4- 3 %.). 

Meanwhile with the help of furnishing or other value addition, one can increase yield by 25-50 basis points. However, beyond a certain point, they can’t be increased. 

In comparison, commercial properties render much higher yields. Grade-A office spaces can easily offer an average yield in the range of 6-7%.  Heightened economic activities coupled with a stable macroeconomic outlook in FY 23 are also auguring well for the commercial leasing in the country. Meanwhile, after a prolonged period of WFH, most organizations are implementing Back-to-office initiatives, fuelling demand. 

Retail is also resuming after facing the whiplash of the pandemic. FY 23 is expected to be marked by a surge in transactions in the high street, hypermarket, supermarket, mall spaces, etc. Retail units can give yields to the tune of 8-9% and can be a prudent investment option. 

Alternative CRE assets to invest

In the commercial segment, other subcategories are also climbing up the curve and piquing investor interest. For instance, warehousing is drawing investor interest in big volume. As per Knight and Frank’s research, in FY 21, warehousing transactions amounted to slightly less than 2.95 million sq. ft, jumping significantly from FY 20, when it totaled 1.29 million sq ft. The warehouse market in India will continue to spiral upwards, stemmed by growth in the consumer internet space, packaged food, FMCG, etc. Warehouses in India can easily give returns in the range of 5-6%, much higher than the residential market. 

In a time, when there is a growing appetite for low-risk but high-return investment, commercial assets will be the preferred investment option. Despite fallouts from the rise in oil prices, the Indian economy will continue to recover in the current fiscal, thereby ensuring an enabling environment for commercial leasing. Meanwhile, the residential sector will also grow in a positive direction fuelled by an expansive middle class and growth in urbanization. However, the rental yields will continue to be in the lower range, weighing on the overall ROI. - Authored by Nakul Mathur, MD, Avanta India.