Why Invest in Commercial Real Estate?
Any good investor knows investment opportunities are not a one-hit-wonder. Investments involve both risk and reward. This balance must be considered every time investments get made and especially when you invest in Commercial Real Estate.
So, it is critical to have a diverse investment portfolio. If an investment fails, the investor can reap the benefits from a different investment and compensate for his losses. This diversification extends to investment options like stocks, bonds, and CREs (Commercial Real Estate).
Commercial real estate is a desirable investment opportunity due to its stable nature. Regardless of fluctuations in the market, investing in commercial real estate brings promising cash flow and asset appreciation. Investors proficient in asset management and not looking for a short-term financial gain can opt for such an investment process. Once purchased, commercial real estate can become an extremely lucrative and stable source of income for the distinct future.
The following are the reasons why one should invest in commercial real estate:
Bringing Diversification to an Investment Portfolio
Every investment comes with a certain degree of risk. The best way to combat this risk is to have a diverse assortment of investments. It will allow the investor to compensate for any loss he might have encountered with other investment avenues. Investment in commercial real estate offers stability in the sense that there is no high risk. If the investor can afford commercial real estate, it can get easily turned into a lucrative income source. Commercial real estate investment can act as a long-term safety net against other investments with a higher risk factor.
Long-term Cash Flow Stability:
A common trope for commercial real estate are long-term rental agreements. Owners of commercial real estate lease the property to tenants. The tenure for these leases is for 3 to 5 years. It allows for constant cash inflow for that period without any further expenses. It makes commercial real estate an excellent option for reducing cash flow volatility in the long run. Commercial real estate investment has also shown to be less volatile than standard investments in stocks. Short-term events less impact real estate investment as they get publicly traded, allowing evening out of valuations.
Creating a Hedge Against Inflation:
The economy often undergoes inflation. In such a situation the price of buying goods and services goes up. By investing in commercial real estate, investors can benefit from inflation in the economy. During inflation, the number of wages paid and profit also increases. It allows real estate owners to charge more for the use of their property. Due to the increase in pay scale, the tenants of the estate will also have no issue paying the increased charge. By having the commercial real estate rates increase at a slightly higher rate than the inflation itself, property owners can create an inflation hedge that adds to the already existing organic growth.
Limited Working Hours:
With the lease of real estate, there is not much to keep track of business-wise. Apart from the collection of rent and the occasional need for checkups and maintenances, owners of the leased properties need to burn the midnight oil. Most commercial properties that have gotten leased will at most be at the risk of a break-in or any damages caused by the tenants themselves or a natural disaster. It boils down to the day’s tasks of managing the different properties during the day. The business for the owner ends with the occupants’ business when it comes to commercial real estate.
Bringing Tangibility to the investment:When investing in commercial real estate property, the assets involved are tangible. It means that the investor can physically touch and see the assets. It allows the investor to evaluate the property for themselves. For many, this offers a degree of security over investing in nontangible assets like shares, bonds, and stocks. By having a tangible property, the owner can still use the land for sale or restructure the property if damage occurs. Evaluation of the physical aspects of the property itself, like its overall condition, and the locality the property is situated in.
Tax Benefits:The most significant incentive for investing in commercial real estate is the massive tax benefits. In the case of investment in stocks and bonds, it is tough to save on taxes unless it is for retirement purposes. On the other hand, owning commercial real estate can help save up on taxes in multiple ways. With time, it gets expected that the value of the property will rise. But owners of commercial real estate can depreciate the value of the property. By doing this, a lot of tax can get saved on income. If the owner can appropriately structure the commercial real estate, he can claim tax deductions based on interest expenses, depreciation of the buildings, and others.
Remodeling Hard Assets:Unlike digital assets like bonds and stock that can disappear in a single day, hard assets like real assets retain more permanence. Being a hard asset, commercial real estate retains intrinsic value for the building and the land it gets built. Real estate can get used to developing other goods and products. It organically increases the value of the property itself. This remodeling can help increase the price of commercial real estate. The owner of the property can further maximize the benefits by increasing the max occupancy.
Who Can Invest In Real Estate?
Ideally speaking, people with limited resources cannot invest in real estate. But today due to LLCs a lot of people own a stake in one establishment. People who have been in business and want to establish a wider array of holdings can invest in real estate. Some people see this as an opportunity to generate stable cash flow for the future and hence consider this as a post-retirement option. New and aspiring businessmen are branching out to commercial real estate to gain experience as property owners and landlords.
When Should You Invest In Commercial Real Estate?
According to studies, commercial real estate demands, unlike residential properties are always on the rise. Let us take a thorough look at the factors associated with an investment in commercial real estate:
- The initial consideration should be all about the subjective interpretation of the entrepreneur. If his willingness to take risks is high and he has a general idea about how much he wants to invest, he should go forward with the investment. An investor should also be clear about the reason for his investment.
- The second thing to take into consideration is the location of the real estate property. If the location is upscale the demand and price for the property are going to appreciate more than similar properties. The lease contracts and how long the leaseholds true should also get considered.
- Ultimately it is crucial to strike a balance between the risk and its returns. Most experienced investors prefer using a stable income-generating source over a quick income-generating source. Smaller investors should not invest without proper counsel.
Factors Determining Real Estate Investments
- Demand and Supply: A street-smart investor analyzes the market before committing head first to any investment project. Every small market has its array of finished products and unfinished products. However, in case of a huge rise in the supply of the stock of projects, the price is bound to come down and in case of an atrocious rise in demand, the price of the properties is going to shoot up.
- Tenants: A good investor will always look for quality tenants. Multinational companies in the form of tenants are going to increase the value of the property and pay their rent on time. They are also more likely to take longer leases and pay better deposits to appreciate the value of the property.
- Interiors: Who takes on the responsibility of doing the interiors can also contribute to the length of the lease. Generally, offices in India get provided to the tenant without any furnishings. The wiring and the electrification, ceiling, and air-conditioning are done only after occupancy. A tenant can ask an investor to do the furnishings and the investor covers with added costs. However, a smart investor would ask the tenant to do his furnishing. When a tenant commits to the furnishings he is likely to stay longer to recover his investment.
- Understanding the Difference between Base Rent and Fit-out Rents: Builders often try to be wily to the investors by confusing them between basic rent and fit-out rent. They add the two components to add to the value of the property. Fit-out rents are generally short-term and stop being a part of the total value of the property. When the fit-out rents get over, there is a drop in the overall return on the property and the investor finds it problematic to get the property out on lease at a price that would enable him to break even.
- Understanding the Lease Structure Properly: Commercial lease structures are generally different from residential lease structures. It is either a nine-year or fifteen years. In contrast to residential properties, the tenants can leave at any time they deem fit and the investor will not be able to withhold their departure. There is a provision, however, of a lock in a period where the tenant will not be able to leave, say within the first three years. Ideally, the longer the lock-in period of the tenant, the more profitable it is for the investor.
- Understanding the Symbolic Implications of Security Deposit: Generally, when a prospective tenant offers the investor a security deposit that covers the rent of at least a year it is a good sign. This means he views this establishment as a long-term option. If someone bargains with how many months’ worth of rent he is going to cover, it should be considered a red flag. This might imply that he is looking for a short-term fix or there are financial problems that might become a problem in the long run, especially while trying to recover rent and maintenance rents.
- Diversification of Your Resources Is the Key to Success: Diversification brings great joy to any investor. If an investor decides to commit all his resources to one establishment, then in the case of an unforeseen vacancy, all his revenue-earning sources will be blocked. On top of that, taxes and electric bills, and maintenance will still have to be paid regularly. So it is advised that a smart investor should try and get hold of different properties that pay well.
- Quality: In the end, everything boils down to the quality of the product. If two buildings are located in the same neighborhood, chances are the one that looks great with better amenities is going to get occupied sooner. More affluent clients like multinational corporations are always up for a great building with better views, fancy lobbies, and state-of-the-art elevator facilities. Buildings that are certifiably better with LEED gold authentication will appreciate faster than an average building and doing so will keep themselves in a better state of liquidity than others.
Investing in commercial real estate is typically a long-term endeavor. Potential investors should know that opting for such an investment is a capital-intensive process. But, there’s a way to invest in commercial assets without burning a hole in your wallets – via fractional ownership. It makes commercial real estate investments affordable and accessible to retail investors. Visit Assetmonk’s website to know more.
Investing in CRE FAQ's:
CRE lending is the acquisition of the necessary mortgages and similar financing of the property by the buyer in order to purchase the real estate property.
It is not necessary for a buyer to have a broker with them when seeing the property. Although having a broker will allow the buyer to view more and have access to the entire property for judgement as opposed to the restricted access if he or she were to go alone.
The value of the commercial real estate is calculated by price per square feet of the land each month or year.
After purchase of a CRE, any changes that will or can be made can either be borne by the tenants or the landlord. This is up to the owner and the tenant to negotiate and come to an understanding.
CAM charges are all the Triple Net charges like taxation , maintenance and insurance of the CRE.