Pre-Leased Assets Investments Analysed

Pre-Leased Properties Investment Considerations

Pre-Leased properties are generally sold on the basis of the rental return being received from the property. The yearly rental (on per sq.ft basis) is capitalized at a certain expected return (the expected return that investors are ready to accept in that micro market) and that capital value is taken as the rate per square foot for that specified property.

There are three things to keep in mind while analyzing an investment opportunity:

1. The rent accruing from the property
2. The capital value that it is bing sold at.
3. The annual ROI

There is a very simple correlation between the three:

Annual Rent / Capital Value = ROI

When any one of these three numbers is out of sync with generally accepted numbers for that micro-market then the property should be deemed to be mis-priced.

We need to analyze the pricing at two levels :

• Pricing within the micro market (Golf Course Road, Gurgaon for example) : Ideally if the rental and the capital value are in tune with the market values for comparable properties in that area the property will be fairly priced as per that location/micro market (example : Golf Course Road, Gurgaon).
• Pricing of the Micro Market (e.g. Golf Course Road, Gurgaon) vis-a-vis the Region (e.g.:Delhi NCR) as a whole : Even if the property is fairly priced in the micro market If the return accruing from the property is not in tune with the average expected return in that region (6.5%-7% in Delhi NCR as a whole for example) for a commercial property then the entire micro market maybe over-priced and hence not worth investing in.

One must however factor in sight variation to the tune of 10-15% in the price of the property depending on the quality of the tenant and the terms of the lease (for example a PSU Bank as a tenant will be a good investment bet at a return 15% below the average expected return since the risks are considerably reduced with a PSU Bank as a tenant).

Effects of Demonetization on Yields in Delhi NCR:

Post Demonetization with a reduction in black money availability in the market most buyers would look to buy pre-leased assets in full cheque. There are two very different forces at work here which could impact the capital value and hence the yield:

1. With removal of cash from the market – buyers investing in properties in full cheque would expect a higher return on their property (compared to before where they were ready to settle at 6-7% due to deployment of cash).
2. Interest Rate Reduction would exert a downward pressure on the yields from fixed return monetary instruments which would have two impacts which should support the prices of the rented property:Demand for pre-leased assets is likely to go up as other fixed return investments become less attractive.
3. Supply of pre-leased assets would reduce as people who own rented properties would be less inclined to sell as other options with fixed return are likely to be less attractive.

Considering the impact of the above two points we strongly feel that the disappearance of cash from the market would have a greater impact hence resulting in a slight price correction and thus an increase in yield. We should ideally look at the yields going up by 50-100 basis points and settling in the 7-8% range.