How do real estate returns in India’s office sector compare with that in the residential sector? Measuring total returns (comprising the rental yield and capital value appreciation), we see that the Grade A office market outperformed the residential sector in seven major cities across the country.

Chart 1 City-wise comparison between office and residential returns index
*Base Year – 2Q12 = 100
Source: JLL Research

Chart 2 shows performance in both sectors over time. Prior to 2012, the residential sector delivered relatively higher returns on the back of capital appreciation at a faster rate. On the contrary, the commercial real estate sector’s gradual recovery in the post-global financial crisis period was underpinned by steadily improving rents.

However, the office sector has emerged as the leader in real estate returns across all cities since 2H 2013, sustained by improving occupier sentiment and reducing vacancy rates in prime office corridors. This resulted in rents rising at a faster pace than residential capital value appreciation over the same period. This also coincided with stronger interest in quality assets from institutional investors. We observed a divergence in terms of the type of institutional money coming into the real estate sectors, with more equity instruments deployed in commercial properties and debt deployed in residential properties.

Chart 2
Source: JLL Research

What this means for investors

The impending REITs make an even more compelling case for retail investor to participate in commercial realty in the near future. However, residential properties still retain many attractiveness.

Despite its moderate returns over the past three years, one must consider additional factors when comparing returns from the residential sector. First, costs of funds for purchasing residential properties is lower – loan rate are about 100-150 bps lower when compared to the purchase of non-residential assets. There is also the added benefit of a reduction in taxable income for the interest amount paid on home loans. In contrast, interest paid for non-residential loans can only be booked to the profit and loss statement if rent from the asset is a principal source of income; otherwise, no tax benefits are available for such investors.

On the other hand, retail investors looking to invest in commercial space is constrained by the larger amount of capital investment required, limited availability of trophy assets (these are usually sold at a premium and on a complete asset basis to large institutional investors), as well as more restricted tax benefits that encourage such investors to invest their money in the residential sector.

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