ADVANTAGES AND DISADVANTAGES OF INVESTING IN COMMERCIAL REAL ESTATE

You were always interested to have income generating property in your investment portfolio to diversify your funds.

It is a wise thought but a word of caution to all those investors!

Where there is money involved with lucrative returns, there is bound to be risks occurring. Thus, before investing, take time and analyze the advantages as well as disadvantages of the proposal to make an informed decision.

There are two ways of investing in commercial real estate. One is through direct investment and the other through REITs.

Let us now analyze the benefits versus risks of each plan independently which will help you in the decision making process.

Direct ownership. An individual can come into possession of the said property by purchasing directly from the property developer or through a real estate broker/agent.

Pros.

• Regular income source in addition to the primary revenue inflows.
• It requires limited operational management and monitoring unlike other businesses.
• Useful asset which can be used for taking loans or as collateral when funds are required.
• It is one of the few assets which appreciates with time, if the market is favorable. Also, an investor can reap more than 100 % of the initial investment which many financial products in the market cannot offer.

Cons.

• Huge investments which may run into crores depending on the location.
• Properties are ridden with litigation. Hence, the buyer has to do extensive research before buying.
• Property as well as the income from the property is taxable and it is on higher side when compared to other available instruments in the market.

The property market is subject to fluctuations. Hence, the income generated may vary with the current estimated value.

REITs. If you do not have the required capital or risk appetite (as property prices are prone to fluctuations) to directly invest in commercial real estate, do not fret. Invest through REITs!

REITs or “Real Estate Investment Trust” is an enterprise that owns or finances income producing properties and by buying their shares, one can become a part owner but without the risk or huge expense involved. REIT’s invest in income generating properties and the revenue from the same is distributed to individual share holders as returns or dividends. Usually, REITs specialize in only one category be it office spaces, warehouses, shopping malls, residential units etc.

REIT’s investment pattern in property is of three types: -

1. Equity REIT’s: The concerned enterprise fully owns the revenue generating property. One distinct difference between Equity REITs and real estate entity is that the former should purchase and develop its properties principally to drive income but the latter can sell it and is not liable for continual engagement with the owners.

2. Mortgage REITs: These enterprises extend loans to real estate firms or property management group, directly or indirectly. The returns churned out from the same are passed onto its individual shareholders.

3. Hybrid REITs: As the nomenclature goes, it is a combination of both – Equity and Mortgage. The percentage in each category depends on the risk appetite of the enterprise.

Pros:

• Regular income source in addition to primary revenue inflows.
• The investor enjoys the flexibility to be part owner of desired real estate project without massive investments i.e. investors may not be able to afford direct investment into lucrative and up market properties.
• Investment in direct property cannot be easily liquidated, if required. This is not the case if investment in property is done through REITs. In case of the latter, if funds are required on a short notice, shares can be traded and required amount realized.
• Minimal or no requirement of operational management.
• Transparency and flexibility are among the most critical benefits that an investor receives in REITs. Transparency is possible since the investment happens through trading of shares in an open market which is regulated by a government body. Flexibility is offered in terms of buying and selling the shares.

Cons:

• Since the returns are market linked, there is always bound to be risk on the level of proceeds.
• If the said enterprise is declared bankrupt or forecloses, the entire risk of losing the money will be the responsibility of the investor.