This article will help answer the following questions.
- What is a preleased property?
- How does it work?
- What is yield?
- Why should you invest in pre-leased properties ?
A Preleased (pre-rented) property is a property on sale, one which has already been given on lease to a tenant/ lessee and is generating a monthly rent.
The concept of rental yield is fast catching the imagination of investors in India. Investors invest into Commercial Real Estate (CRE) with a view to earn a fixed income coming in the form of rent.
Investors are transacting in (CRE) which is in demand and offers high annual rental yield. There is a healthy demand from corporates from the IT and BFSI segments, which 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 8% to 12% or even more.
Pre-Leased Commercial Properties command high yields.
These pre-leased properties provide fixed income. Here, the aim is to lease out to quality tenants, earn lease income over a 7-10 year period and subsequently exit with a moderate to high capital (property) appreciation.
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.
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.
How to calculate the rental yield
The calculation is simple. You are arriving at a price after including the total purchase price minus security deposit paid by the tenant. 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.
The key factors driving such investments are obvious as CRE demand is growing at a robust pace, vacancy levels going down and rising rentals. In a falling interest rate environment, where other financial products show signs of volatility, investment in pre-leased CRE will provide stable returns in the form of regular monthly returns and capital appreciation on exit.
Advantages of investing in preleased properties
- Assured returns right from Day 1: Usually, people buy properties and rent it out later. This means that the buyer looks for the tenant himself and has to wait for return, after purchase, till the time the property is actually rented out, whereas in the case of a pre-leased commercial property, returns are assured right from day 1. This means there is a zero waiting period for Return on Investment (ROI).
- Fixed Monthly Returns: Since these properties are already occupied by tenants at the time of purchase, a lease agreement is already signed, security deposit collected, and lock-in period defined. Hence, a monthly return is fixed and assured. It is a very safe investment.
- Tax Saving: The rent received by the buyer is taxable. However, a 30% standard deduction is always allowed for repairs and maintenance, regardless of the actual amount spent. This means that you save tax on 30% of the amount and pay tax for 70% of the rent income received.
- Rent Escalation: Rent escalation is pre-defined in the lease agreement. Rent appreciation is usually 15% after every 3 years.
- Lock-in Period: A lock-in period is defined in the lease agreement. Lock-in period is the minimum time frame in which the tenant cannot vacate the property.
- High Capital Appreciation: Of course, the value of properties increases over time. But commercial properties witness higher capital appreciations. Not only do you benefit from the assured rents, but also from the value appreciation of your property.
- Low risk factor: The property is already occupied for a specified duration, which means that returns are guaranteed atleast for the next few years and the required legal documentation has already been done. It is a safe long term investment. Such properties are rarely affected by economic slowdown or recession in the realty market. This is because the duration of stay of the tenant and rent terms are already specified. Current market factors do not affect it.
- Easy Bank Loans: Financial institutions lend loans easily for pre-leased properties, even to the tune of 90% of the cost of property.
With investment in completed (ready possession) CRE, there are no risks associated with Land, Project Approvals and Constructions delays. Regulatory initiatives including GST, and RERA as well as demonetization have resulted in higher transparency that would further boost the commercial real estate space demand making it a compelling investment choice.