Investing in real estate has long been touted as one of the best ways for individuals to create long-term, sustained wealth. Some dip their toes into the waters by investing in a single rental property. Others selectively invest in small-scale apartment buildings. But few truly understand the advantages of investing in commercial real estate – apartment communities, retail centers, office buildings, land development and more.
Individuals tend to shy away from commercial real estate, and understandably so. It can be a complicated asset class to fully understand, especially if trying to own and manage property on your own. Instead, investors routinely opt to put their money into “safer” investment vehicles like stocks and bonds. In doing so, they miss out on the tremendous opportunity and benefits that real estate has to offer.
In our experience, investing in commercial real estate is a highly attractive fixed-income strategy relative to investing in equity markets. When you invest alongside an experienced team, real estate can prove to be a great risk-adjusted return alternative.
We elaborate on these and other benefits below.
The Primary Benefits of Investing in Real Estate
- Portfolio diversification.
Institutional investors, such as pension funds, endowments and insurance companies, have invested in commercial real estate for decades. Their ability to bring tens of millions of dollars to single transactions gives them an upper hand in purchasing some of the most desirable real estate. On average, institutional investors have about 10 percent of their equity invested in real estate assets, a number that continues to climb.
One of the reasons institutional investors are drawn to real estate is that it allows them to diversify their portfolios away from more traditional stocks, bonds and securities.
Take, for example, the 20% Rule made famous by Yale’s Investment Office, which has one of the highest performing endowments of all time. Their investment strategy includes a portfolio balanced as follows:
- 30% domestic stocks
- 30% bonds and securities
- 20% real estate
- 15% foreign developed markets
- 5% emerging markets
Just as Yale dramatically reduced the endowment’s reliance on stocks and bonds 30 years ago, we expect individuals to follow suit. Today, the average investor’s portfolio has only 3% percent of funds allocated to real estate. Many individuals want to diversify their portfolios by adding real estate but simply have not known how to get started. As new mechanisms become available to allow individuals to co-invest in institutional-quality real estate, the number of people adding real estate to their portfolios is expected to skyrocket.
2. Risk mitigation.
Those looking to diversify their portfolios often do so as a way of mitigating risk. The stock market, for example, can experience dramatic ebbs and flows – even on a daily basis. Real estate, on the other hand, has very little correlation with the stock market. It is an illiquid asset class that cannot be easily purchased or sold and therefore, its values tend to remain relatively stable in the short-term. Longer-term, real estate also provides a tremendous hedge against inflation as inflation generally causes property values to rise.
Moreover, specific property types can offer further downside protection. For example, multifamily property is considered a relatively “safe” investment. This is because even during an economic downturn, people will need somewhere to live. In fact, during a recession, some people may sell their homes and move into rental housing. It can take time for people to rebuild their credit and purchase homes after a significant recession, which creates prolonged demand for multifamily housing even when the economy is otherwise struggling.
3. Regular, passive income.
Commercial real estate tends to generate regular, passive income for investors. Office, retail and hospitality properties tend to have long-term leases in place, resulting in an infrequent turnover. Multifamily properties have leases that turn over with greater frequency, but well-located properties can generally be re-leased quickly to ensure steady cash flow year in and year out.
In addition to routine cash flow distributions, investors may also realize a significant, lump-sum payment upon the asset’s refinance or disposition.
4. Tax benefits.
Real estate is a highly tax-advantaged industry. Most properties are purchased with leverage (i.e., a mortgage). The sponsor can then take a deduction for mortgage interest paid during that fiscal year, which tends to be higher in the first years of ownership as the loan begins to amortize.
Commercial real estate can also be depreciated over a 27.5-year or 39-year horizon (depending on the property type), even if the property technically appreciates in value. Depreciation can be used to offset a significant portion of the passive income collected each year, which puts more money back into investors’ pockets.
Finally, investors will also benefit from tools like the 1031 exchange, which allows them to sell an asset and roll the proceeds into a like-kind asset without having to pay capital gains tax. This is how many investors grow their portfolios and create sustained wealth for generations to come.
As you can see, there are many reasons why individuals should consider following in the footsteps of well-heeled, sophisticated institutional investors. Investing in real estate is a great way to diversify your portfolio, mitigate risk, and earn highly tax-advantaged, passive income on a monthly basis.
Are you ready to add real estate to your portfolio?
Contact us today to learn more about how our HLC Direct platform has provided an important in-road for those looking to invest in institutional-quality real estate for the first time.
