Commercial Real Estate (CRE) has consistently proven its worth as a resilient investment, even amidst significant market disruptions like the COVID-19 pandemic. According to JLL, despite the turmoil in other sectors, CRE has largely held firm, demonstrating its potential as a valuable addition to an investment portfolio.
Here are 7 top reasons to invest in commercial real estate:
- Cash Flow
CRE can generate strong and stable cash flow. Unlike stock distributions, which might offer an 8-9% compounded annual return, CRE investments can deliver significantly higher cash flow, potentially up to 15% annually over the same period. This return is often structured to provide regular dividends—monthly, quarterly, or annually. Investors in CRE also typically benefit from more favorable tax treatment on these returns.
- Equity Investment: This involves purchasing minority ownership in a hard asset like an apartment community or office building. The steady cash flow desired by investors is generated through rising rents.
- Debt Investment: This entails investing in a real estate loan, with the underlying asset (land or a building) serving as collateral. A key attractive feature of this type of investment is that it is generally structured to provide a fixed return.
- Diversification
Diversification is crucial for any savvy investor, and CRE offers a distinct advantage by having a low correlation with the stock market. This means that when the stock market experiences a downturn, CRE investments may remain unaffected, providing a buffer against losses. A truly diverse portfolio should include CRE to protect against market volatility. Furthermore, within the CRE sector itself, there’s ample opportunity for diversification across various property types (e.g., industrial, multifamily, retail, office) to further spread risk.
- Tangible Asset
Real estate is a tangible, “hard” asset, unlike stocks which can lose all value. Regardless of market fluctuations, real estate inherently maintains intrinsic value from the physical building and the land it sits on. This tangible asset can be utilized to produce goods or services, which is reflected in the property’s price. While property values and occupancy rates may fluctuate, and even foreclosures can occur, the property’s value will never drop to zero as long as the land exists. This inherent value provides a foundation for potential profitability and the ability to restructure or remodel the asset to create new opportunities for value.
- Tax Advantages
CRE offers significant tax advantages for investors. Unlike stocks and bonds, where capital gains taxes are often immediately due (unless held in a retirement or qualified plan), CRE can help reduce or even avoid these taxes. As properties in prime locations appreciate, investors can still make deductions, such as depreciation, which reduces their taxable income. Upon selling a property, investors can postpone capital gains taxes altogether through a 1031 tax-deferred exchange, provided they reinvest the proceeds into a “like-kind” property within a specified timeframe.
- Inflation Hedge
Commercial real estate serves as an effective hedge against inflation. As the economy grows and the cost of goods and services rises, property owners can typically increase rents. This is supported by increased earning power among the populace in an expanding economy, enabling them to afford higher rents. Data from the Federal Reserve Bank of St. Louis indicates that commercial real estate prices increased by an average of 5% every quarter from 2012 to 2016, while the Consumer Price Index remained around 2% during the same period, demonstrating CRE’s ability to outpace inflation.
- Leverage
Utilizing leverage, such as a fully amortized mortgage, allows CRE investors to view each monthly rent payment as a savings program. As rent payments cover the outstanding debt, the asset’s leverage is reduced, and the investor’s equity in the property increases. For instance, a property acquired with 20% equity and 80% debt only needs to gain 20% in value for the investor’s initial equity to effectively become 100% of the original equity contribution. While the risk of foreclosure exists if payments cannot be maintained, leverage can significantly amplify returns.
- Co-investing with a Sponsor
The traditional method of investing in commercial real estate from scratch—individually searching for properties, managing them, or employing a broker—is often suboptimal for the average investor due to the lack of expertise and infrastructure. The JOBS Act of 2012 has revolutionized access to CRE by enabling crowdfunding. This legislation makes CRE investment more accessible and potentially safer for a broader group of people.
Today, many large investors co-invest with “best-in-class” sponsors. Private equity investment companies like Trion Properties, with over 20 years of real estate investment experience, are examples of such sponsors. They specialize in acquiring properties requiring moderate to heavy rehabilitation on a mid to long-term investment horizon, focusing on maximizing investor returns by increasing the property’s net operating income. Co-investing with a sponsor provides an excellent pathway to generating passive income and building wealth over time.
In summary, CRE presents a growing opportunity for investors. Thanks to the JOBS Act of 2012, crowdfunding has made CRE investment more accessible to a wider audience. Commercial property’s nature as a tangible asset, its capacity to yield robust and steady cash flow, its role in portfolio diversification, its favorable tax treatment, and its function as an inflation buffer all contribute to its status as a sound investment that retains value as long as land exists and improvement potential is present.