Recent instability on Wall Street has been a warning to investors and demonstrated the importance of diversification into real estate. Commercial real estate (CRE), in particular, has been a reliable investment regardless of market cycles. The volume of capital that is being invested in commercial real estate further demonstrates its proven worth as an asset.
According to JLL, despite the turmoil caused by COVID-19 in other sectors, CRE has once again shown its resilience. This doesn’t mean there may not be problems in the future, with hotels and retail buildings, in particular, but so far, CRE continues to stand firm.
This opens the door 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 portfolio is diverse. CRE may be a positive addition to an investment portfolio. Here we have the 7 top reasons to invest in commercial real estate.
1 Cash Flow
CRE can provide a strong and stable cash flow. Like stock distributions, CRE investments are structured to deliver regular dividends to investors each month, quarter, or annually. But unlike stock distributions, the return is usually greater.
CRE outperforms the S&P 500 over more extended periods by up to 2 x – in the public and private markets. For instance, investors can receive an 8 – 9% return compounded annually from stocks but get up to 15% cash flow from CRE over the same period.
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 means buying minority ownership in a hard asset, like an apartment community or office building. Rising rents provide the steady cash flow investors desire.
This is investing in a real estate loan, with an asset (land or 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.
Every savvy investor knows how important diversification is to their portfolio. But traditional investments of stocks and bonds, mutual funds, or EFTs aren’t diverse enough to ensure stable returns when the market faces a downturn.
Diversification protects against 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. When the stock market plummets, the CRE investment may be unaffected. Volatility in one doesn’t necessarily mean anything at all in the other.
Within CRE, there is room for more differentiation. There are different commercial property types, and a portfolio may be further diversified by broader investment in CRE.
3 Tangible asset
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 property’s price.
Property values may rise or fall, but this tangible asset won’t go anywhere. There will always be value to the investment. Though rents may or may not be paid, occupancy may fluctuate, and in the case of bad operators, there could even be foreclosure – but the property’s value will never go to zero. As long as there is land, there is the possibility of profitability. The investment can never be worthless.
The hard asset can be restructured or remodeled to create new opportunities for value.
4 Tax advantages
There are tax advantages to owning CRE. With stocks and bonds, the investor must put aside some 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. However, 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, the investor may make deductions (depreciatiation) that 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 time.
5 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 for rent.
Information collected from the Federal Reserve Bank of St. Louis stated that CRE prices increased by 5% every quarter, from 2012 to 2016, while the Consumer Price Index remained at 2% for the same period.
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 asset’s leverage. This increases equity, so the investor returns to the point of exit.
For instance, a property purchased with 20% equity and 80% debt only has to obtain 20% in value for the equity to be at 100%. Of course, there is a risk of foreclosure if payments can’t be maintained.
7 Co-investing with a sponsor
There was a time when anyone who wanted to invest in commercial real estate did so from scratch – searching for viable properties, managing them, or employing a broker. However, the JOBS Act 2012 has changed that. It never was an optimal method anyway. The average investor doesn’t have the expertise or infrastructure to buy, sell, operate, manage, or improve commercial properties.
Best practices for buying CRE is to co-invest with best-in-class sponsors. Today, the largest investors aren’t doing it on their own. With crowdfunding, investors can take what they have and co-invest with sponsors who know what they’re doing.
Private equity investment company, Trion Properties, is a best in class sponsor for those looking to invest in CRE. They acquire properties that require moderate to heavy 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.
CRE is a growing opportunity for investors. It’s made more intriguing to some 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.