Why should you consider commercial real estate as an asset class worthy of investment in your retirement or investment portfolio?
In choosing an investment, you basically have five choices:
- Stocks;
- bonds, CDs, and savings accounts;
- commodities;
- collectibles;
- real estate.
Let’s explore each of these investment options. First, individual stocks and mutual funds. Stocks and mutual funds can be a good choice, and in fact, we allocate some capital to this asset class in our personal portfolios.
But the stock market is volatile and can turn on a dime.
If investor sentiment is at a low point when you need to sell, things can turn out quite badly.
Moreover, flash crashes, Bernie Madoff type frauds, insider trading schemes, high-frequency hedge fund trading abuses, dot com busts, and other market manipulations and excesses have caused many Americans to leave the stock market.
Investment in stocks or mutual funds is down from 67% of all Americans in June 2002 to only 52% in April 2013
These disturbing developments led Charles Schwab, the legendary discount brokerage and mutual fund CEO, to write about these abuses and manipulations in a recent Wall Street Journal guest editorial.
If Mr. Schwab is concerned, then perhaps individual investors have good reason to be concerned as well.
Over very long periods of time, stocks can return about 9% per annum including dividends.
So, while stocks can make for a reasonable investment into the long-term economic prosperity of America, one may want to look at alternatives for at least part of one’s investment portfolio.
The second option is bonds, CDs, and savings accounts.
These investment options are thought to be safe because they generally provide for a return of capital if held to maturity. But these investments yield relatively low returns, and they can be devastated by inflation. In an inflationary environment where interest rates are rising, bonds and CDs sold prior to maturity must be sold at a loss to the principal investment. So, inflation creates a double whammy on bonds and CDs—lower real rates of return and loss of principal when sold prior to maturity.
The third option is commodities, like gold and other precious metals, oil, and agricultural products. Investing in commodities can be complex. The investment can offer diversification and inflation protection, but commodities generate no income or economic output whatsoever. The investor simply owns the commodity, hoping to profit from an increase in price at a later date. Some would call these investments mere price speculations.
The fourth option is collectibles, like rare coins, stamps, and art. Collectibles are a lot like commodities; they too do not generate income or productive outputs and are just speculations on future prices. Besides, they are difficult to buy and sell and often come with high commission schemes.
The last investment option is real estate. As an investment, commercial real estate, when structured properly, can be an IDEAL investment—that’s I-I-D-E-A-L.
Let me explain.
The first I is for Income. Commercial Real Estate generates rents. Rents can provide positive cash flow and relatively predictable returns. The second I is for Inflation Hedge. Research demonstrates that commercial real estate values are positively correlated with inflation so that as inflation rises, so do the values of commercial real estate.
This makes sense because rents can be raised to keep pace with inflation. This is even more true in markets that are not overbuilt and where there is strong rental demand and job grow–the fundamental characteristics of emerging real estate markets in which we invest at Right Place.
The “D” in IIDEAL is for depreciation. A real estate investor can benefit from tax deferral through the income tax depreciation deduction. This is a tax benefit not available from the other investment options I have mentioned.
E is for equity build-up. When a property generates a positive cash flow, the tenants, over time, pay off the mortgage. When the property is sold, the equity build-up is converted into cash.
The A in IIDEAL is for appreciation. Over time real estate values increase if the property is bought right, and this is especially so in emerging markets that are poised for rapid growth. Moreover, this appreciation enjoys favored tax treatment as a long term capital gain if the property is owned for the requisite holding period.
Finally, L is for leverage. While too much leverage can create unnecessary risk, it is typical to finance the majority of the purchase price on commercial properties. So, the owner puts down only a fraction of the purchase price, but that person gets to keep 100% of the profits. While the lender is taking the bulk of the risk, the borrower gets to keep all of the profit. This is a key differentiator between real estate and the other investment vehicles I have discussed.
Commercial real estate has two other positive attributes. Research has shown that
(1) returns from commercial real estate are uncorrelated to those of stocks and bonds and (2) perform better than stocks and bonds on a risk-adjusted basis. This makes commercial real estate ideal for consideration in a diversified portfolio.
For these reasons, a prudent investor may wish to consider commercial real estate in connection with retirement and investment planning.
If we can be of any assistance to you YOUR COMPANY NAME as you consider whether commercial real estate has a place in your portfolio, please let us know.
We provide our investors with the opportunity to participate in emerging real estate markets without the hassle of managing properties or the headaches of dealing with tenants.