Investment in Commercial Real Estate vs Residential Real Estate: A Rental Yield Comparison

Indian real estate is once again poised for rapid growth. It is standing firm, supported by strong economic sentiments and low interest rates. Along with end-user activities, investments are receiving a boost.

Meanwhile, the age-old debate over whether to invest in Commercial Real Estate (CRE) or Residential Real Estate (RRE) resurfaces. Both asset classes have advantages and disadvantages. There is no standardised set of parameters that can be used to compare CRE and RRE. When it comes to rental yields, however, CRE outperforms its residential counterparts significantly. Commercial assets such as offices, retail, warehouses, and so on remain safe bets because they can generate recurring rental income.

Rental yields in CRE are higher in India

Globally, housing rental can be a source of smart returns. The downtown area of London can easily provide a 4.5% yield. Similarly, Dubai and Bangkok can post returns of 5.5% and 5.3%, respectively, creating a favourable environment for increased investor participation.

However, the same viewpoint does not apply in the Indian market. In India, the rise in rental rates has not kept pace with the rise in property prices.

Housing yields range between 2-3%, which is significantly lower than in international markets. In Delhi NCR, rental yields are slightly less than 3%. It usually falls between 2.5 and 2.7% in the Mumbai Metropolitan Region (MMR). South of Bangalore, upcoming IT corridors have the potential to generate up to 3.3% (the general average is 2.4-3%).

Meanwhile, furnishing or other value addition can increase yield by 25-50 basis points. They cannot, however, be increased beyond a certain point.

Commercial properties, on the other hand, produce significantly higher returns. Grade-A office space can easily provide an average yield of 6-7%. Increased economic activity, combined with a stable macroeconomic outlook in FY 23, bodes well for the country's commercial leasing industry. Meanwhile, following a period of prolonged WFH, most organisations are implementing Back-to-office initiatives, which is fueling demand.

Retail is also resuming after being disrupted by the pandemic. The fiscal year 23 is expected to see an increase in transactions in the high street, hypermarket, supermarket, and mall spaces, among other places. Retail units can provide yields of 8-9% and are a safe investment option.

Alternative CRE assets to consider investing in

Other commercial subcategories are also climbing the curve and piqueing investor interest. For example, warehousing is generating a lot of investor interest. According to Knight and Frank's research, warehousing transactions totaled slightly less than 2.95 million square feet in FY 21, up significantly from 1.29 million square feet in FY 20. The warehouse market in India continues to grow as a result of consumer internet growth, packaged food, FMCG, and so on. Warehouses in India can easily yield 5-6% returns, which is much higher than the residential market.

Commercial assets will be the favoured investment option at a time when there is an increasing appetite for low-risk, high-return investments. Despite the effects of rising oil prices, the Indian economy will continue to improve in the current fiscal year, creating an enabling environment for commercial leasing. Meanwhile, the residential sector will expand positively, fueled by an expanding middle class and increased urbanisation. However, rental yields will remain in the lower range, weighing on overall ROI.

Authored by Ankit Aggarwal, MD, Devika Group