Residential real estate is one great way to own a piece of real estate for investors, but it certainly isn’t the only way. Investing in commercial real estate such as shopping malls, medical office buildings, large properties, and hospitals – may provide investors with an income stream, potential tax benefits, protection against inflation, and significant growth opportunities. In addition, real estate is a great way to add diversification benefits when combined with other types of uncorrelated investments such as stocks and fixed income securities. Therefore, commercial real estate can provide investors with a means of protection against volatile market conditions.
investment opportunity
Years ago, commercial real estate investments were only achievable by institutional and wealthy investors and trust funds with significant financial resources. Today, with the advent of products such as real estate investment trusts (REITs), many investors now have access to commercial real estate investments and opportunities that were previously only available to the cream of the crop.
How it works
The most widely used vehicle for investing in commercial real estate is a REIT. Although investing in commercial real estate was restricted to wealthy individuals and companies 50 years ago, since the inception of the REIT, the real estate market has attracted a much larger and wider group of investors because it has allowed regular investors to participate. REITs are like most other funds in the way they obtain capital for their operations. They collect money from investors and pool all the money to acquire real estate like hospitals and office buildings. As long as REITs closely adhere to the laws applicable to them, most notably distributing at least 90% of their total taxable income to investors, they avoid double taxation of their income at the REIT level. This distribution is the main source of income for REIT investors.
When investors put their money into any REIT, they are putting their money in the hands of real estate professionals who monitor changes and trends in the real estate market, mortgage price movements, regional trends, and other factors. In addition to all external factors, the success of the REIT will also be influenced by the fund manager’s skills, experience, and talent.
REITs come in two forms: traded and non-traded fashion. Each has its advantages and risks. However, this article focused on non-traded REITs.
Potential benefits
Non-traded REITs may offer the following:
fixed income streams. Non-traded REITs may provide a revenue stream in the form of monthly or quarterly distributions. This gives fixed income investors a steady cash flow.
Client protection. Although fluctuations in the economy can affect real estate values, REITs that invest in quality real estate assets can maintain their value.
Capital increase. With a long enough time horizon, real estate can provide investors with back discretion that can translate into great rates of returns.
Inflation protection. Real estate usually bears the corrosive nature of inflation.
tax advantages. Many investors benefit from owning real estate investments because the investor’s taxable income is reduced by taking advantage of depreciation deductions. When the asset is sold, the income protected by deductions is taxed at potentially lower capital gains taxes.
the potential risks
The following risks are possible with non-traded REITs:
Some REIT real estate property may have been purchased at an excessively high price which could limit the overall growth of the REIT portfolio because the REIT may run the risk of not being able to sell the property at a more appreciative price. These types of properties may or may not provide cash flows to REITs.
Non-traded REITs are usually suitable for long-term investment horizons of 5 to 10 years which makes them illiquid investments.
The investment objectives mentioned in the prospectus of the real estate investment fund are an objective and are not guarantees. Customers may see a difference in the distributions they receive and the expected level of distribution rate.
Commercial real estate investment strategies
Think carefully about the risks you are looking to take in order to justify the expected return. Higher returns usually go hand in hand with higher risks. Individual investors need to get comfortable with the degree of risk they are willing to take and then increase their returns to their unique level of risk without leaving your comfort zone.
REITs are usually divided into three main categories, each with its own advantages and risks:
1. Primary investment programs focus on long-term real estate holdings in order to generate steady income streams for their investors and possibly some upside on the back end. Investors who find these programs attractive usually focus on receiving an income stream to supplement their existing income.
REITs that fall under this category of primary real estate investments invest their money in well-established real estate markets with a focus on high-quality, stable, well-maintained and low-leverage properties. Buildings generally have minimal necessary maintenance such as repairs.
The managers select properties in a variety of markets and look at the financial stability of the tenants in the properties they choose.
2. The value-added group invests in real estate that has the potential to provide investors with a significant capital increase. Therefore, these properties carry with them a higher level of risk and are generally financed with some degree of leverage. Investors who seek asset value rather than current income in their investment plans may find this group of REITs more suitable for their investment goals.
When purchasing these types of properties, the managers are willing to purchase properties that may have had some operational or management problems such as average or below average occupancy rates. In hopes of turning around these investments, the REIT may seek to somehow improve or reposition troubled areas of the property more often by finding higher quality tenants. Once their bids increase the value of the asset, the manager may consider selling the property to get the winnings.
3. An opportunistic REIT seeks to invest in real estate that will yield the highest possible returns and therefore may accept a large amount of risk to reach its objectives. Investors in these types of REITs need a minimum current income and are looking for a significant capital increase in the short term.
These investments are not generally suitable for individuals seeking a steady stream of income, but rather those seeking to increase the total returns in their portfolios through capital appreciation. REIT principals create value by finding properties in geographically diverse markets where growth potential is high. Fund managers invest in real estate for a short period of time and are generally willing to recapitalize some of the properties to increase returns.
You don’t have to do it alone
REITs can be complex investments to evaluate and more complex to incorporate into your existing portfolio and investment goals. The Isakov Planning Group’s financial advisor can help you decide if REITs are right for you.