Should You Invest in a Pre-leased Property?

Is it worth investing in a pre-leased property which otherwise seems attractive? Many experts seem to think so! However, there are quite a few things that you should keep in mind in this regard.

What are Pre-leased Properties?

They are basically those properties which have already been leased/rented out and are now listed for sale. The biggest win-win proposition for the buyer on paper is the fact that from day one, he or she will start earning rental income from the property.

This is the biggest value proposition of a pre-leased property, especially one that has a stable and reputed tenant. Commercial real estate investments have started booming in India once again after a temporary lull due to the COVID-19 pandemic. Many investors, including UHNWIs (ultra high-net-worth individuals), HNWIs (high net-worth individuals), businessmen, corporates and affluent home owners are realizing the value of investing in commercial real estate as a safety net for lifelong income and bigger appreciation potential. Reports highlight how commercial real estate may offer anywhere between 9-15% in terms of rental yields while residential properties usually offer anywhere around 2-6%.

Naturally, considering these figures, commercial real estate requires a bigger payment than a residential unit. If it is a pre-leased property with regular rental income, then the ticket size automatically increases considerably. However, their propensity to generate income from day one and reasonable break-even periods are now prompting many affluent investors and buyers to scout for Grade-A pre-leased commercial units. These include land parcels, industrial parcels, warehouses, office spaces, retail spaces, and more. The aim here is to choose a property which already has a high-quality tenant and earn regular income over a few years before exiting at a higher valuation and profit.

Benefits of Pre-leased Properties

• Fixed monthly income or rental returns.
• Higher potential for capital value appreciation than other property types.
• Reasonable break-even periods for investments, with opportunities for profitable exits down the line.
• High-quality tenants ensure stable returns and renewals.
• Prime or fast-growing locations mean that the property will always be in demand.
• Zero risks, i.e. you start earning from the beginning.
• Higher liquidity from the outset.

Cons of Pre-leased Properties

• Considerably higher price and initial investment than regular commercial or residential properties.
• There could be issues where tenants do not renew their leases, leading to a gap in income before a new tenant is found.
• Accompanying maintenance, repair and renovation costs for continuing to attract quality tenants.

Some Other Aspects Worth Remembering

• The lower your entry prices into the segment, the higher your overall return.
• The quality of the tenant is of paramount importance. Insurance companies, banks and PSUs usually ensure 6-8% in rental yields and they remain for longer durations.
• IT or ITeS firms, BPOs and MNCs along with other corporates usually ensure rental yields between 8-12% on average. However, they may not always stay for such a long period. The usual estimate is that if the tenant is paying a substantial amount for interior design, i.e. Rs. 2-4,000 per sq ft, then it is usually for a longer period.
• Rental yields are calculated after accounting for basic pricing, car parking costs, and stamp duty without the security deposit. The annual lease/rent will be divided by this final price for obtaining the yield.
• The usual lease period is three years and this may come with 15% rent hikes at the time of renewal as per standard clauses.

Suppose you are getting a pre-leased property for Rs. 6 crore with a total leasable space of 10,000 sq ft. You are hence purchasing the property in a prime location at Rs. 6,000 per sq ft in this case. After taking the car parking and other costs into account, you will have to finally shell out Rs. 6.50 crore (inclusive of stamp duty). The security deposit is then adjusted and your net outflow is Rs. 4.80 crore (just assuming these figures).

Now, coming to the rental amount, suppose it stands at Rs. 120 per sq ft and the property tax amount is Rs. 30 per sq ft. Hence, your net rental charges will be Rs. 90 per sq ft. This means that you will be earning Rs. 9 lakh per month or Rs. 1.08 crore per year. Now deduct expenditure on maintenance, facilities, repair and renovations and so on. You may end up with a figure around Rs. 70 lakh in net rental income every year. Hence, your gross rental yield is 22.5% (annual gross rental income/cost of the property * 100). Your net rental yield is 14.58% which is a handsome figure by all standards (using the same formula, i.e. net income/cost of the property *100). Going by the above calculation, you will break-even on your net investment of Rs. 4.80 crore in roughly 7 years. Thereafter, it will only be profit at your end.

Your Take-Away

If you have the money to invest and the patience to wait for a longer horizon, then you can consider investing in pre-leased properties at a higher ticket size. However, make sure that you buy a property which has a quality tenant and do the math in terms of calculating your break-even point. Check the area, future potential, market value of the property, available infrastructure and factors like repairs/maintenance/renovations as well. Take everything into account before signing on the dotted line.