Investing in commercial real estate or CRE can be financially rewarding and personally gratifying. Many investors who are serious about creating and securing generational wealth choose to put their money in commercial properties. After all, CRE investing offers many benefits: lower economic risks, portfolio diversification, and a unique pride of ownership knowing that your properties play a crucial role in the community and the economy overall. Below we discuss several key reasons why it’s a good idea to invest in CRE:
Why Invest in Commercial Real Estate?
Diversify Your Portfolio
Do you already have investments in bonds, stocks, and perhaps even income-generating residential properties? Then diversifying to commercial real estate can be a great way to strengthen your portfolio and make it more well-rounded.
CRE is a hard asset. Unlike soft assets such as stocks and bonds, CRE is tangible—something you can see and touch, something you can directly control. There is no risk of financial scandals or crises, causing your commercial property to disappear overnight. What’s more, commercial property investments don’t behave in the same way as bonds or stocks. There is a very low correlation between CRE and the stock market—which means that a sudden downturn in equity markets will not necessarily affect your commercial property investment.
The ability to differentiate within CRE is another selling point that attracts serious investors to commercial properties. For example, you can choose to put your money in different commercial real estate sectors to cater to different demand drivers. There are many and constant opportunities to take advantage of. Is the economy experiencing job growth? This usually correlates to a higher demand for office space. Is there an obvious upsurge in household formations? This will likely increase the demand for apartment complexes. Diversifying your mix of CRE investments can mitigate risks and further strengthen your position in any market.
Commercial properties and generally offer higher returns on investment compared to residential real estate. CRE yields 6 to 12%, whereas residential typically yields only 1 to 4%. ROI on commercial properties is also higher than average returns on bonds, stocks, and other such traditional investments.
Excellent returns on CRE investments are attributable to lower vacancy risks associated with these types of properties. You can collect rental payments from multiple tenants in different industries each month if you have a mix of retail, apartment, and office space, for example. And should one tenant decide to end their lease early, you can still count on income from your remaining tenants as a safety net. Most other asset classes don’t offer the same security of having a fallback.
Better Cash Flow
Commercial properties can offer future financial gains when they appreciate over time. But not only that—they also create present cash flow from rental payments collected from commercial tenants. This can create a stabilizer in your portfolio, balancing out volatilities in stocks and equities, which are largely valued based on their potential for long-term appreciation.
And should the property increase in value over the years—perhaps because of its excellent location or the continued development of the area surrounding it—this translates directly to increased rent and therefore increased cash flow. Indeed, a sizable portion of total investment returns from commercial properties comes from current cash flows resulting from rental income.
This characteristic of CRE investments is ultimately what long-term investors seek. It’s an opportunity to invest in future wealth while enjoying access to the immediate and ongoing cash flow that is likely to rise over time or remain steady.
Longer Leases & More Stable Income
There is much less tenant turnover in commercial properties because leases tend to be longer in this sector than residential leases. This is yet another major benefit of CRE investing. Most commercial tenants—especially bigger brands—are willing to sign leases that last for many years, thereby lowering turnover risk. Long-term lease agreements provide a steady source of cash flow and operating income.
Direct investments in CRE also show much less volatility compared to stocks and publicly-traded REITs. Direct investments are not publicly traded, so they are much less affected by short-term events that can rock the equities market. This helps smoothen out valuations in general.
Excellent Hedge Against Inflation
Commercial properties are great inflation hedges for investors who want to protect their money from rising prices that decrease their purchasing power. Hard assets serve this purpose well, in general. They tend to increase or at least hold their value over the years, even as prices of services and consumer goods go up.
And in the event of extreme inflation, CRE owners have the option to offset increasing costs by increasing rent. Commercial properties may benefit from inflation when you look at it this way.
In general, real estate benefits from an increase in the prices of goods and services in the broader economy. Why? Because increasing profits and wages typically increase how much property owners can charge for their commercial space and how much tenants can afford to pay.
It’s interesting to look at the property appreciation that resulted from the last recession. CRE prices were shown to increase at significantly higher rates than inflation. Data suggest that commercial real estate prices increased by a whopping 5% (at least) for every quarter from 2012 to 2016. Notably, the consumer price index stayed below 2% during the same time frame. Provisions for rent escalation provides another hedge against inflation, on top of organic rent growth.
All the Benefits of a Hard Asset
Whereas stock investments can technically disappear into thin air, hard assets like commercial real estate have intrinsic value both in the land and the building. The great thing about hard assets is that they can be used in different ways to maximize income. And for example, CRE can be remodeled to serve a different purpose or increase its value. Landlords also have the option of maximizing occupancy to increase cash flow.
Potential Tax Benefits
CRE investors may claim tax deductions related to interest expense, depreciation, and many other factors. As of 2018, the IRS allows commercial property owners to deduct as much as 20% of their net income from the property from their income taxes. This pass-through tax deduction can add up.
Start Investing in Commercial Real Estate.
Not too long ago, direct investments in commercial real estate were mostly available only to the ultra-wealthy and institutional investors. CRE properties cost tens (if not hundreds) of millions to acquire, after all. But since the passing of the JOBS Act of 2012, almost anyone can now participate in CRE investing. The minimums have been lowered to as little as $5000, thanks to crowdfunding options.
Aside from outright property ownership and traditional direct investing, you can now buy publicly-traded REITs or real estate investment trusts. These trusts own a wide range of income-producing commercial properties, and as an investor, you receive a portion of their earnings. It’s an uncomplicated and liquid way to quickly add commercial real estate to your portfolio. That said, REITs’ performance tends to mimic the behavior of bonds and stocks because they can be purchased and sold at will.
Another option to consider is real estate crowdfunding, and if you are interested in handpicking individual CRE projects to ensure that each one aligns with your investment goals. These projects are often listed online, making them so much easier to access. It’s a great way to take advantage of opportunities outside your state or city.
Depending on how much you intend to invest, it might make sense to create an LLC structure so you can enjoy tax advantages. LLCs allow the pass-through of interest expense, depreciation, and other allowable deductions.
To understand Commercial Real Estate Investing, you can contact our CRE investment consultant now!