Commercial Realty

Lease vs sale of commercial real estate: Which is a better option?

[] Will developers and occupiers prefer leased commercial spaces in the aftermath of the pandemic, or will outright purchase/sale of real estate be the norm? We examine…

What works better in the commercial space – sale or lease? The answer would vary among developers and occupiers, as leasing caters to certain requirements, while sales may be the answer to other needs.

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When malls and organised office spaces started evolving in India and occupiers shifted from neighbourhood shops and high street to malls, while office spaces shifted to swanky buildings, developers learnt an important lesson – that recurring revenue through the lease model made more sense. However, most of the developers lacked strategy with their commercial portfolio, in terms of sales and marketing. Consequently, some developers became successful while others burnt their fingers.

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Post-Covid-19, the debate as to whether sales model works better with commercial spaces or lease model brings more cash flow, has again become a topic for discussion. In the changed scenario, developers, as well as space occupiers, are again busy with their own cost and benefit analysis. Most of the malls and office spaces operating in India’s leading cities have registered less footfalls and empty spaces since the Covid-19 outbreak. This trend was evident even before the pandemic, due to oversupply, lack of demand and the emergence of the e-commerce sector.

In the office space segment, the nature of occupiers is changing and so is the demand. Developers can no longer rely only on large floor plate occupiers led by the IT/ITeS sector. In terms of occupiers, analysts tracking the market point out that the buyers of commercial spaces (office, as well as retail) are stuck. Those who have taken it on lease still have a way out. They are trying to either renegotiate the rent or get into a revenue sharing model with developers. According to analysts, the immediate future of commercial space is lease model and out-of-the-box consumer connect to drive footfalls.

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Sale vs lease of commercial real estate: Cost and benefit analysis

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It is said that most of the commercial real estate developers have huge debt in their books. To keep the business floating, many of them want to offload the inventory and ease the burden. However, for developers who are not over-leveraged or under heavy debt, the leasing model makes more sense. The leasing model also allows for capital appreciation year-on-year. More importantly, most of the businesses are presently preferring to avoid outright purchases that will make real estate a major part of their capex.

A look at some of the large-format, branded malls and office spaces, suggests that the lease model is easy and better, in comparison to the sales model in commercial property. The lease model helps both the parties in their own ways. While a lessee can opt out of the deal if the business is not going as planned, the developer has the double advantage of recurring lease money, as well as capital appreciation.

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Ashish Narain Agarwal, founder, and CEO, believes that the lease model is ideally better as the initial cash outlay is low and payments are in parts. In lease deals, start-ups and small companies stand to benefit, as their income is still building up and they can avoid huge payments. “The onus of maintenance of the property is on the owner. The occupier does not have to worry about its upkeep. In case one wants to change the location, he can do so freely. Also, property appreciation or depreciation will not have a major effect in a rental agreement,” says Agarwal.

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Advantages of outright purchase / sale model in commercial realty

A lot also depends on the scale of the project. For example, in projects by developers targeted at small-scale retailers, where the ticket size is not large, one tends to prefer outright sale. However, for a large-scale retailer, the preference is always for a lease model. In terms of occupiers’ profile, the domestic retailers and office occupiers prefer to outright buy the space and leverage the appreciation, while international retailers do not commit to outright buying and instead, prefer long leases.

Amit Goenka, MD and CEO at Nisus Finance, categorically says that whether to lease or buy, will depend on the buyers’ capex capability, ability to service debt, asset lightness, and long-term vision as it is more expensive to lease commercial space in the long run.

Read also : Emerging demand drivers of commercial real estate in India

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Commercial property lease vs sale

Globally, the preferred model for commercial real estate transactions is the lease model. Global corporates prefer to utilise capital for business expansion, rather than locking it in a hard asset like real estate.

Most of the successful commercial realty projects in mature property markets, have the presence of institutional investors or Real Estate Investment Trusts (REITs). With REITs getting initial success in India, this will become more popular and provide an exit route to developers.

The lease model also makes better business sense for retailers and small office occupiers who do not wish to block capital and be able relocate when the business demands.

In the emerging scenario, post-pandemic, retailers are renegotiating rents with their landlords and asking for revenue-linked lease models. On the contrary, if rentals begin to skyrocket in future, there may be renewed interest for outright purchase of commercial real estate.

Ultimately, ‘lease only’ may not be the only business model for commercial space developers in India. We may well see the emergence of a hybrid model of lease and sale. While lease will remain a preferred model of business in the commercial segment in the immediate aftermath of the pandemic, out-of-the-box strategies and business-friendly initiatives like revenue sharing, will determine the future success of malls and office spaces.

(The writer is CEO, Track2Realty)

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Category: Commercial Realty

Debora Berti

Università degli Studi di Firenze, IT

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