Top 7 Reasons To Invest In Commercial Real Estate

Commercial real estate (CRE) 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 real estate investor. 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 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 favourable tax treatment on those returns.

There are two options for investors:

Equity Investment

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.

Debt Investment

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.

2 Diversification

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 underperforms, investors may still gain returns from investments in other classes. CRE should be a part of any genuinely 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 remodelled to create new value opportunities.

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.  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 (depreciation) that reduce their taxable income.

When a property is sold, the investor can postpone the profits altogether 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.

6 Leverage

The investor can look at each monthly rent payment as a savings program when the CRE asset has a mortgage with a fully amortised loan. 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. 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.