[ecis2016.org] What is a pre-leased or pre-rented property and does it make sense to invest in one? We examine…
A pre-leased or pre-rented property is one that is leased to a party and then, sold to a buyer along with the tenant. Along with the sale, there is also a simultaneous transfer of the ownership of the property; meaning the lease agreement is also transferred to the new owner. A pre-leased property comes with many benefits, such as higher capital appreciation, regular income and zero waiting period. Investments with regards to pre-leased commercial properties have seen an uptick in the recent past, making it one of the most favourable options for property investors, entrepreneurs, corporate houses and ultra-high-net-worth individuals (UHNIs). However, before investing in a pre-leased property there are some key aspects to be taken care of.
You are reading: Things to consider while buying pre-leased real estate
Location is perhaps the most important factor that determines the value of any real estate asset. Investors looking to invest in pre-leased office space, should look at investing in the central business areas in a city. Investors looking for pre-leased retail shops and banks should look at investing in areas with better accessibility to public transport (preferably situated on the main road), high footfall and good frontage. A prime location will always command a higher value and will result in a lesser turnaround time, in case you plan to sell the property. Appreciation of the asset’s value will always be determined by its micro-market and the city that investors choose to invest in.
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Ensure that the lease is for a long period, as finding new tenants is an arduous and time-consuming affair. Longer lease terms ensure greater stability of the asset. For example, banks usually have long lease terms that ensure reliable and stable returns.
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In both, commercial as well as residential properties, rental yield indicates return on investment. While rental yield is calculated by the annual rental received divided by the property price, an investment property should generate income and increase in value, or better, do both. One can determine the same when the rental yield is higher which indicates stronger returns from the property. Currently, rental yields are around 7%-8% for office spaces, while it is 5%-7% for bank properties and retail, and 8%-9% for warehouses.
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The best way to choose a tenant, is always through professional advice. Before finalising a deal, investors should evaluate the tenant’s financial background and quality. This helps to ensure that rentals are paid on time. Also, it is crucial to understand how the tenant is going to use the space. If the tenant plans to use it as an office space or a headquarters and has spent a considerable amount on furniture and fittings, it means he/she has invested more and there is a probability that they are seriously interested in the property and can stay for long.
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While one can understand the valuation of a property by studying data of the last transaction in the building and area, talking to property consultants and property owners in the building will help one to better understand the valuation of properties in a locality. As it is already leased out, one can expect a maximum 5%-10% premium over the value of a vacant property. If the rent is inflated and the return is good, that does not mean you should buy it. One should not only look at rental yield but also at the property’s value with an equally careful lens.
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Lock-in is the period within which a tenant cannot vacate the property. If he vacates the property, he may have to pay huge penalties (usually the rent till the end of the lock-in period). A longer lock-in period shows higher stability and commitment on behalf of tenants.
Maintenance costs borne by one as an incoming owner should not be too high. It is imperative to calculate one’s net rent in hand after paying all maintenance costs and property taxes. Then, calculate one’s net return on investment.
Higher building occupancy means higher asset stability and higher feasibility of getting another tenant, if the tenant vacates due to any reason. The property can get leased again as the building occupancy is high, provided tenants like the location.
Grade A properties make a better investment option as they attract quality tenants and resale value is always maintained. Grade A properties are always in demand for buyers. The common area of the property is also maintained well. Hence, Grade B or C properties should only be opted for, if the tenant quality is good and the building is well maintained.
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A deposit paid by a tenant is usually a commitment toward the property. If a tenant vacates or if there are damages, the deposit amount insures the investor. A security deposit is given by the tenant to an investor when he buys the property. The higher the deposit, the better it is. Investors can keep the deposit amount in a bank and earn interest on it (this increases his total returns) and an investor is also ensured of a large amount in case the tenant vacates. The investor can keep the deposit amount to cover the unexpected vacancy loss to some extent.
A commercial pre-leased property offers low to medium risk that includes fixed rental income and good yield, coupled with capital appreciation of the same over a period of time. Thus, it ensures stability of a safe haven option to invest in, with assured returns.
(The writer is co-founder, PropReturns)
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