Lock-in periods are key to investing in commercial properties

Commercial properties, be it warehouses or office buildings, are great investments. They offer high yields, are stable, and appreciate over time. However, as with everything related to investments, taking a little care always helps. After all, for the want of a nail, the kingdom was lost.

It is common knowledge that location impacts the value of a property. If it is a commercial property with a high degree of accessibility, it is natural for the asset to fetch high rent. So, when offered an option to invest in an asset, should you jump at the opportunity?

Let not the promise of great returns screen your eyes to the other factors at play here. A crucial but often ignored part of CRE investments is the lease and lock-in periods.

Lock-in periods form part of the lease agreement. The important bit is - while landlords are bound by the lease period, tenants are bound by the lock-in period. If a property has a lease period of 9 years and a lock-in period of 3 years, the tenant has to stay committed to the space for 3 years or pay up the rent for the lock-in period if they decide to shift bases. 

Why is this so important?

A lock-in clause ensures stability on your returns and protects your investment from floundering. Even if the tenant decides to jump ship or the market conditions turn sour for some reason (a pandemic for example), a decent lock-in period comes in as a saving grace. It buys you time to find a new tenant or wait for the market to recover while still giving you a return on your investment.

So, what’s a ‘decent’ lock-in period? 

In commercial real estate, the lock-in periods can vary from 3 years to anything like 9 years. That’s a sizable range and it mainly comes down to the type of asset and tenant in question.

Companies that are into manufacturing require an industrial space that they can customize to the last bit. They look for longer lock-in periods (sometimes 15 years or longer) because their work floor is the most stable part of their business.

White-collar companies need offices. Desks, chairs, a couple of computers, and their requirements are met. Needs are more fluid and so these companies look for lock-in periods on the shorter end of the spectrum (less than 5 years).

Right smack in the middle lie spaces that are offered for warehousing which generally taken up by logistics and e-commerce firms. These lock-in periods generally tend to stay within 5-9 years.

When deciding to invest in a CRE, bear in mind the kind of property and the lock-in period it has no matter who the tenant is. If the period is too short (say less than 3 years), the tenant might not be serious about sticking around. If you cannot renegotiate for a longer lock-in with the tenant, it is best not to opt for the asset. On the other hand, If the lock-in is too long, you can be stuck with a rent that’s lower than the market average, which is still fine as long as you are making consistent returns.

There are many other finer details that you can look at when deciding to invest in commercial real estate, but considering the situation at hand, paying attention to this crucial factor can save you from making a rash decision. There might be better opportunities right around the corner.

To know more about how you can invest in stable, high-yield commercial assets for as little as 25 lakhs, visit strataprop.com