Commercial real estate (CRE) opens doors for a whole new kind of savvy investor. The appeal of traditional investments like stocks and bonds or mutual funds is understandable, but a balanced investment portfolio is diverse and CRE can make a positive contribution to it. Here are the top reasons to invest in commercial real estate.
Passive Income Cash Flow
CRE can provide a strong and stable cash flow. Like stock distributions, CRE investments are structured to deliver regular dividends to investors monthly, quarterly, or annually depending on the deal. However, unlike stock distributions, the return is usually greater.
CRE outperforms the S&P 500 over more extended periods by up to 2x in the public and private markets. For instance, investors can receive an 8 – 9% return compounded annually from stocks, but get up to a 15% cash flow from CRE over the same period of time.
Not only is the cash flow greater with CRE, but investors enjoy more favorable tax treatment on those returns.
There are two options for investors:
Equity Investment
Equity investment is buying minority ownership in a hard asset, like an industrial or office building. Rising rents provide the steady cash flow investors desire.
Debt Investment
Debt investment is investing in a real estate loan, with an asset (usually a building), acting as collateral. One of the most attractive things about this kind of investment is that it is generally structured to give a fixed return.
Tax advantages
There are tax advantages to owning CRE. With stocks and bonds, investors must put aside a part of their income to pay capital gains taxes. Unless the investment is a part of their retirement account or part of a ‘qualified’ plan, these taxes must be paid. On the other hand, with CRE, capital gains may be reduced or avoided altogether.
If the investor owns properties in prime locations, their value should increase over time. However, investors may make deductions, such as depreciation, that will reduce their taxable income.
When a property is sold, the investor can postpone the profits altogether through a 1031 tax-deferred exchange. They can use this 1031 exchange if they invest in a similar property within a specified amount of time.
Tangible assets
Real estate is a hard or tangible asset. Unlike stocks that can be of value one day and of no value the next, real estate will always maintain intrinsic value from the building and the land. This tangible asset may be used to produce other goods or services, which is reflected in the price of the property.
Property values may rise or fall, but tangible assets will not go anywhere and there will always be value in the investment. Though rents may go unpaid, occupancy may fluctuate, and in the case of bad operators there could even be foreclosure, the value of the property will never reach zero. As long as there is land, there is the possibility of profitability. The investment will never be worthless.
The hard asset can be restructured or remodeled to create new opportunities for an increase in value.
Inflation hedge
Commercial real estate is a hedge against inflation. As the economy grows and more is charged for goods and services, landowners may increase the rent they charge. Growth in the economy means that people earn more money, so they can pay more rent.
Diversification
Every savvy investor knows how important diversification is to their portfolio, but traditional investments of stocks and bonds, mutual funds, or EFTs are not diverse enough to ensure stable returns when the market faces a downturn.
Diversification protects against these losses. If one investment class under-performs, investors may still gain returns from investments in other classes. CRE should be a part of any truly diverse portfolio.
CRE has a low correlation with the stock market, so when the stock market plummets, CRE investments may go unaffected. Volatility in one does not necessarily mean the other will be affected as well.
Within CRE, there is room for some diversity. There are different commercial property types, and a portfolio may be further diversified by broader investment in CRE.
Leverage
When the CRE asset has a mortgage with a fully amortized loan, the investor can look at each monthly rent payment as a savings program. The rent pays the outstanding debt and reduces the leverage of the asset. This increases equity, so the investor returns to the point of exit.
For instance, a property purchased with 30% equity and 70% debt must only obtain 30% in value for the equity to be at 100%. Of course, there is a risk of foreclosure if payments can not be maintained.
Co-investing with a sponsor
There was a time when anyone who wanted to invest in commercial real estate needed to do so on their own – search for viable properties, manage them, or employ a broker to do so. However, the JOBS Act 2012 has changed that. At any rate, this was never an optimal method as the average investor does not have the expertise or infrastructure to buy, sell, operate, manage, or improve commercial properties.
The best practice for buying CRE is to co-invest with best in class sponsors. Today, the largest investors are not doing it on their own. With syndication and crowdfunding, investors can take what they have and co-invest with experienced sponsors who know what they are doing.
Private equity investment company, Tepuy Properties, is a best in class sponsor for those looking to invest in CRE. They acquire properties that require low to moderate rehab on a mid to long-term investment horizon. They focus on maximizing investor returns by increasing the net operating income from the property.
Co-investing with a sponsor is an excellent way to create passive income and increase wealth over time.
In summary
CRE is a growing opportunity for investors. It has been made more intriguing to investors by the JOBS Act 2012, which allows investors to crowdfund – making investing in CRE more accessible and safer for a broader group of people. Commercial property is a tangible asset that yields a robust and steady cash flow and represents diversification in any investment portfolio. CRE investors receive favorable tax treatment and the benefit of an inflation buffer. CRE is a sound investment that will never zero out as long as there is land and improvement potential.