Investors buy commercial real estate for rental cash flow from office, retail, multifamily and warehouse leases, a depreciation write-off on a 39-year schedule, appreciation and diversification, and because an illiquid asset does not swing with the daily stock market. Brokers and property managers let the owner hold it passively.
Commercial real estate is property utilized for business purposes. It is the go-to investment vehicle for affluent investors because of its compelling potential for almost guaranteed long-term cash flow.
As reported on Investopedia, commercial real estate (CRE) investments raked in returns averaging 10.3% in Q1 of 2021. They performed better than the stock market, which only garnered 9.6% on average.
Although commercial real estate returns fell close to 57% in 2020, it’s still a lucrative venture. Compared to other forms of investments, CRE commands higher returns while enjoying a long and predictable return on investment (ROI).
This piece examines the love story between affluent investors and commercial real estate.
Why do the Wealthy Love Commercial Real Estate?
What do rich people invest in? Andrew Carnegie, the industrialist billionaire, once said 90% of all millionaires acquired their wealth through real estate investments. While that is not accurate strictly speaking, it does paint a picture of real estate’s popularity.
The most beloved, of course, is the commercial real estate industry, as it allows the wealthy to make money without direct involvement. Here are some of the other incentives of commercial real estate investments:
1. Not easily prone to irrational market movements
Investments in CRE are safe from a fluctuating stock market because they are not liquid investments. As an affluent investor, you have confidence that the investment will maintain its value despite short-term market fluctuations.
2. Cash flow for reinvesting
Rents generated from multifamily, office, retail, and warehouse leases give the prosperous investor a reliable source of cash flow. An added advantage is the investor will eventually break even and acquire multiple real estate investments from the proceeds.
3. Tax benefits
The government assumes that a building will depreciate over time, whether it does or not. It allocates a useful lifespan of 39 years, so you can write off 1/39 of the property every year.
That means you get to pay less tax from the rental income every year until the 39 years are up. For an investor, a penny saved is as valuable as one earned.
You can take unlimited and legal real estate paper loss against your income. This enables you to preserve your income, hence growing wealth in commercial real estate.
4. Appreciation
If you maintain the CRE property well and its surroundings are developing, CRE increases in value. Appreciation attracts affluent investors because the property attracts a premium during its sale, beating inflation.
Source: RCA CPPI Index
5. It is a long-term investment
An affluent investor wants to grow the investment and eventually enjoy reliable and sustainable returns without the headache of operational management. Premises to live and work are a necessity; therefore, CRE will always be marketable.
CRE requires patience, but is a better long-term investment compared to speculative assets like stocks that can go south with short-term market swings.
6. CRE allows diversified investment
You can invest in varying locations to insulate your income as the various assets face varying market risks. The best way is to invest offshore in other lucrative real estate markets, like China, Sweden, and Turkey. Diversifying mitigates risk and makes income even more reliable.
How do you choose a commercial real estate property to invest in?
Before selecting a commercial property, you should identify market demand, plan finances, and look into the feasibility of the investment in relation to your desired goals.
One of the perks of CRE is you can reap the benefits passively, as you can appoint real estate brokers, attorneys, contractors, and property management companies to manage the property.
That way, you get to enjoy the cash flow, appreciation, and tax benefits without breaking a sweat.
1. Underwriting
Any affluent investor should have a back-of-the-napkin formula to determine if an investment is worth underwriting.
The procedure can be a single metric, such as comparing the asking price per square foot with market rents per square foot. Whether it works for you or not gives you a quick green light or red light regarding the investment.
2. Financial planning
Identifying funding options for CRE investments is vital when selecting CRE properties. You need to review liquidity and set aside capital for expenses after an initial investment.
3. Market Demand
Consult expert brokers to help identify market and current trends, select ideal locations to set up properties, and achieve your financial goals.
What are the main commercial real estate investment strategies?
1. BRRRR
The BRRRR model involves buying property below market price, rehabilitating, renting, refinancing, and repeating.
2. Land banking
In this strategy, you identify development paths, buy large tracts of land, and anticipate that the land will appreciate with time.
3. Development
To develop a commercial property, buy raw land, then plan what to construct to capitalize on the property’s location to bring in the most money.
4. Fix and Flip
Like the residential concept, you buy a property below the market rate, upgrade or make necessary repairs, and place the commercial real estate for sale.
5. Wholesaling
A wholesale commercial real estate investor finds a good deal, puts the property under a contract, then sells the contract to an owner-occupant or another real estate investor.
6. Owner-occupied
Comparable to house hacking in residential real estate, you purchase a CRE, occupy part of it to run your business, then lease the rest of the space to other companies.
Conclusion
Wealthy investors love purchasing commercial real estate property because it is a solid yet passive investment vehicle. It also offers enticing tax benefits, does not bend to market fluctuations, and will likely keep appreciating in the long run.
Frequently asked questions
Is it worth it to invest in commercial real estate?
For the investors this article describes, the draw is a combination: rent from office, retail, multifamily and warehouse leases; a depreciation write-off spread over a 39-year schedule; appreciation when the property is well kept and its surroundings develop; and an illiquid asset that does not swing with the daily stock market. Whether it fits you depends on market demand, your financing and how the deal measures against your goals.
What creates 90% of millionaires?
The line usually credited to Andrew Carnegie is that 90% of millionaires built their wealth through real estate. This article says outright that the figure is not strictly accurate. What it does show is how popular real estate is with the wealthy, and commercial real estate in particular, because it lets an owner make money without being directly involved in running the property.
Can you invest in commercial real estate passively?
Yes. An owner can appoint real estate brokers, attorneys, contractors and property management companies to run the property and still collect the cash flow, appreciation and tax benefits. That hands-off structure is a large part of why affluent investors favor commercial real estate. Passive does not mean careless: underwriting, financial planning and a read on market demand still come before any purchase.
How does depreciation lower taxes on commercial property?
The government assumes a commercial building loses value over a 39-year useful life, whether it actually does or not. That lets the owner write off 1/39 of the property each year, so less of the rental income is taxed until the 39 years are up. For an investor, a dollar kept out of taxes is as valuable as a dollar earned, and that paper loss helps preserve income.
