“Why should I invest in Commercial Real Estate?,” someonerecently asked me. With the well–publicized drop in residentialprices in some areas of the country, it might seem prudentto be avoiding real estate right now. Fortunately, all real estate islocal, and San Antonio has actually been showing appreciation inprices, even though sales volume has slowed to merely what it wasin 2005.
But commercial real estate is a different animal altogether. First,commercial real estate is strictly property for businesses, i.e., retailcenters, office buildings, warehouses, manufacturingsites, apartments, and land. Secondly, there is lessof it than homes. There are about 14,500 pieces ofcommercial property in San Antonio versus perhaps300,000 homes. Thirdly, commercial real estate iseither for the use of a business or for producing aninvestment return, as opposed to a house you andyour family may live in.
So, why invest in this area? Some of the greatfortunes in the U.S. have been based on real estate.Be it the King Ranch or Donald Trump, propertyinvestment can produce returns far in excess of therate of inflation.
Diversification is fundamental to good financialplanning and that means splitting up your investabledollars into different sectors that will not act similarly.Investing in the stock market, where you can seethe hour–by–hour and day–by–day gyrationsof your portfolio can be stomach wrenching.Real estate trades hands infrequently, so thevaluations are less subject to daily events andmore governed by yearly trends of supply anddemand. Putting a 5% to 15% portion of yourinvestment portfolio in property is a very prudentthing to do. This will help stabilize youroverall returns and real estate may often move in the opposite directionof the stock market. For instance, commercial real estate, asmeasured by the index of equity real estate investment trusts overthe past 10 years, returned a total of 12.4% versus the SP–500 returnsof just under 10%.
Here are the basic ways you make money from investing incommercial real estate:
Income: Commercial investment properties will be leased totenants, like businesses, and retail stores. These leases producerental income for the owner which should create positive cash flowafter the mortgage and expenses are paid. This may produce an incomeof 5% to 10% per year of the amount you invested. Depreciation:Also called cost recovery, this tax write–off shelters some or allof your income from the expense of taxes. You write off the cost ofthe building and some of the building components, but not the landit sits on. Equity build up: Because you can use your rental incomeproduced by your tenants to pay your mortgage, then the part ofyour mortgage that is principal – but not interest expense – reducesthe amount of your loan and thus builds up your equity in the property.Appreciation: The property becomes worth more money 1) asthe rent income goes up, 2) as the market puts a higher value on therents and 3) as the land value goes up. Additionally, the value usuallygoes up in the reverse proportion to inflation so that property isa good hedge against inflation. Leverage: When you borrow moneyto buy the property, you can control the entire property for a smallpercentage of the purchase price. Then because your mortgage isfixed, the appreciation in the equity portion of your investment isamplified. You can control more property for less money. For example,if you buy a property for $4, with $1 of your own and $3 youborrow, and the property goes up in value to $5, then you sell it, payback the $3 you borrowed and keep the $2 left over. You have doubledyour money when the property value went up only 25%. Andthe interest expense of the mortgage is tax deductible.
You may notice that these five elements of commercial investmentform the acronym IDEAL coined by CertifiedCommercial Investment Members (CCIM), theexperts in commercial real estate, a good way to rememberit. This is not to say that commercial propertyinvestment is ideal, but it may be ideally suitedto help you diversify your investments so that youare piece of mind or lack thereof is not tied to onlyone type of investment, like stocks, bonds, gold oroil wells. Spreading your investments into a wellthought out variety of investments is a very smartthing to do and putting some of your hard earnedmoney into commercial real estate investments canpay off for you.
What are the three most important things inreal estate? You are one–third right, LOCATION iscrucial because that is the essential element of propertyĆ¢ā‚¬ā€¯it doesn’t move, in Spanish it is “inmobiliaria”,the immovable. But the other two elements areequally important, like TIMING. A tract ofland on north Loop 1604 in 1980 simply was aranch or ranchette on the famous “death loop,”the two–lane farm–to–market road outside oftown. Now, as time has progressed and thepath of growth has overtaken it, Loop 1604 isa 6–lane expressway with office buildings, retailcenters, and restaurants. But you can also findvacant tracts of land inside Loop 410 that have never been built on,growth has stopped in that area, maybe properties are declining andtime has passed them by. Another example: Californians thought15% per year appreciation was their birthright. Now they have seenthat trend reversed. Like most things in life, timing is everything andreal estate is no exception.
The third element of real estate is PEOPLE. Every property isowned by someone, and after my many years in this business, everyproperty has a story. People who own, buy, sell and use real estateare the real reason it has value or not. People are the true key tovalue.
So when you are considering investing in commercial real estateit is very important to engage a qualified professional, like a CCIM,who can evaluate all of these elements and help you make the rightinvestment decision.
