Investing in Commercial Real Estate: The Pros and Cons
Introduction
It is hard to turn on the TV or scroll through your social media feed and not see something about real estate. Whether it is flipping houses, being a landlord, wholesaling homes, or investing in real estate investment trusts (REITs), ETFs or crowdfunded deals, someone somewhere is telling us how to make money in real estate. Knowing where to jump in can get confusing. Friends and family members with a few rentals might also talk in your ear about supplementing your income and accruing equity. However, to really generate wealth, commercial real estate is a great place to do it.
Like any investment commercial real estate has its risks and they can be substantial, but so can the rewards. Before thinking about the money you can make it is worth knowing about the broad scope of investments that pass for commercial real estate. You might be surprised.
Related: Move Before The Market Does
Commercial Real Estate Defined
Broadly speaking, commercial real estate is any real estate that generates income through rents – with some notable exceptions that we will discuss later. That means your primary residence, in which you live is not considered commercial real estate. However, if you own other single-family homes that you rent out, then these are considered commercial assets. Generally, though, they are not the kind of properties we think about when considering CRE,
rather, the major sectors of CRE include:
- Retail buildings
- Offices
- Medical office buildings
- Warehouses and industrial buildings
- Self-storage facilities
- Multi-unit apartment buildings
- Restaurants
- Healthcare facilities
- Hotels
- Casinos
Mixed-used buildings (usually a mix of retail or office space and apartments)
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High Demand Commercial Real Estate Properties
The commercial real estate industry today is in tremendous flux. Remote working, short-term rental accommodation, the baby boom generation retiring, along with many younger people’s reluctance to be tied down to a mortgage has seen both instability and opportunity arise in equal measures. Here are some of the most burgeoning CRE sectors today:
Senior Housing
Baby boomers are retiring and looking to downsize. They want to be freed from their homes, able to travel, and have repairs and maintenance done when it arises. They also want to be around like-minded friends. Most types of senior housing are monthly rentals and comprise the following groups:
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- Senior Apartments— Apartment for adults over the age of 55. These have a limited number of stairs, low pile carpets, grab bars, and other amenities to enable safe living
- Independent Living (IL)— Similar to senior apartments but with expanded services such as full kitchens, community restaurants gyms, and other amenities to offer a resort-type feel
- Assisted Living (AL)— For seniors who need help with day-to-day living from staff members. Tasks could include helping them to get dressed, manage medications, prepare/escort them to meals, help with bathing, etc.
- Skilled Nursing (SNF)— Full-time nursing staff on hand to help with 24 hours long term and short-term care/rehabilitation needs.
- Continuing Care Retirement Community (CCRC)— The assurance of a place to live for the rest of a senior’s life comes with heavy upfront costs that can run into millions plus monthly service charges.
Multifamily
Any building with five units or more is considered commercial multifamily. Rental housing has been a hot sector in recent years. There’s a shortage of for-sale housing, and ongoing affordability challenges keep many renters from transitioning to homeownership. There’s also a growing population of renters by choice – people who could afford to own but prefer the flexibility of renting. Meanwhile, pandemic-era work-from home arrangements have led some developers to convert under-used office space to multifamily.
Retail
This sector has taken its lumps in recent years, but retail landlords’ fortunes have varied by niche. Out-of-favor shopping malls and big-box centers with poor locations have struggled as Amazon has taken more and more market share from traditional retailers. But prime malls have continued to prosper. And e-commerce hasn’t hurt grocery-anchored shopping centers and neighborhood retail. So a retail center anchored by a Kroger or a Publix is probably doing just fine.
Offices
For decades, Class A office space was the sexiest sector in commercial real estate. The pandemic changed things. Many white-collar employers embraced work-from-home arrangements. And while a significant percentage of office workers might go back to their cubicles, it’s unclear if employers will need office space to the same extent that they once did. Still, office space in city centers and suburbs remains a huge part of the commercial real estate industry.
Medical Office Buildings
A specialty segment of the office market, medical offices have proven themselves to be not just recession resilient, but ecommerce resilient too. Despite the growing trend to telemedicine which generally increases the number of doctor/patient contacts without reducing the number of in-person visits. Patients still need to visit their doctors and with the rapid aging of the American population, this trend is only going to keep increasing in the years to come.
Industrial
A booming sector. E-commerce has fueled the need for warehouses and distribution centers across the country. The industrial sector also can include manufacturing space, auto repair shops and other uses, but much of the growth has been driven by Amazon, UPS and FedEx. These structures are evolving to accommodate robotics and automated retrieval and storage systems.
Self-storage
Americans have a lot of stuff, and self-storage landlords cater to that reality. This property type rents storage lockers to consumers and business owners who need a place for belongings that no longer fit in the garage or the filing cabinet.
Restaurants
The restaurant sector was roiled by the pandemic, but restaurants continue to thrive. In their latest incarnation, many restaurants have added outdoor dining. Many cities have accommodated this trend by narrowing downtown streets and taking over sidewalks and on-street parking for al fresco dining. Another dining trend has been the rise of food halls – shared spaces where multiple restaurants operate with lower overhead than if they occupied a stand-alone restaurant. One reality of restaurants hasn’t changed: Failure rates remain high, as always.
Healthcare Facilities
An aging population means more demand for healthcare – and that, in turn, means more demand from physicians, physical therapists and occupational therapists for space. Medical offices come with some quirks. For instance, cleaning standards are higher, particularly for medical facilities that conduct surgery or handle large quantities of medical waste.
Hotels
While the pandemic cut into travel plans, hotels remain a huge sector in the real estate industry. Tourism hubs such as Las Vegas and Orlando are home to tens of thousands of hotel rooms each. And the nature of hotels means they operate on top of some of the most valuable land in the world, whether it’s beautiful beachfront in California or Florida, prime mountainsides in Colorado or high-traffic areas in Manhattan and San Francisco.
Casinos
Legal gambling once was confined to Nevada and New Jersey. No longer. A wave of gambling legalization has brought casinos to Florida, Illinois and other states. Meanwhile, loosening restrictions around sports betting means that sports books soon will multiply.
Mixed-use Buildings
Many commercial real estate buildings have a variety of uses. Perhaps there’s ground-floor retail and office space on the second floor. Maybe a tower is part offices and part residential units. The potential combinations are endless.
Want to keep up to date on the commercial real estate investment market? Read Alliance’s Blog and stay informed on changing trends as they happen!
Related: Is Inflation On The Horizon?
Pros: Diverse Portfolio and Diverse Investment
If you already own stocks and bonds, real estate can add diversity to your portfolio. The many different CRE asset classes named above offer one type of diversification – not every CRE sector moves in lockstep, so you can build in some diversification this way. What’s more, CRE is tied to the fortunes of a geographic region, another factor that allows for diversification.
A real estate investment also offers the opportunity to be as passive or active as the investor wishes. They can be involved in the management, overseeing construction and upgrades, or simply as an investor with an equity stake allowing others to handle the day-to-day running of the property.
Pros: Low Turnover Rates
One of the big advantages of CRE is the long-term lease a tenant signs. Residential real estate generally operates on a one-year lease, which can morph into a month-to-month lease. CRE usually operates with a minimum 3-year lease and sometimes longer. This reduces tenant turnover and stabilizes the building and cash flow with predictable, guaranteed rent.
Pros: Fantastic Tax Benefits
There are tremendous tax benefits associated with owning commercial real estate. These include the following:
Depreciation
Translated into layman’s terms, this is the wear and tear on a building over time. That time on commercial buildings is 39 years and is calculated by the value of your property divided by depreciation (39). Even if your building remains in immaculate condition the same depreciation calculation applies.
Deductions
Any expenses associated with the property — all maintenance, repairs, property tax, mortgage interest, property insurance, and property management fees — can be deducted at tax time.
1031 Exchanges
When it comes time to sell your property, you can defer capital gains taxes by purchasing another property (of equal or great value) within a specific time frame (you have 45 days to identify a replacement property and 180 days to close on it) with the proceeds from the property. These proceeds never go to you directly rather are held by a qualified 1031 Exchange intermediary, usually a lawyer in a separate account.
Investing in Qualified Opportunity Zones
Another way to reduce an existing capital gains tax liability (and that includes non-real estate associated capital gains such as stocks, bitcoin, precious metals, etc) is to invest it in a QOZ. Similar in some regards to a 1031 Exchange, they offer even more advantages through their step-up tax reduction. Capital gains invested in an Opportunity Fund (a fund designated to invest in a QOZ) are reduced by 10% in five years and another 5% in seven years and can be deferred up to nine years. Future capital gains on Opportunity Fund investments held in the fund for at least 10 years are completely excluded for capital gains taxation.
Pro: The Miracle of Leverage
Another key difference in CRE as opposed to the stock market is the ability to leverage money. By placing debt on an asset, increasing the value, and thus the equity, you can refinance the property and repeat the process, creating more equity.
Con: High Competition
Yes, CRE is a notoriously cutthroat industry, one where fortunes are won and lost. But this is a risk factor that crowdfunding helps you manage. Passive investors now have opportunities to invest with professional, seasoned sponsors.
Any opportunity with the potential to make a lot of money is bound to draw intense competition. With the added incentive of low-interest rates, CRE is a booming investment sector with big money players scouring the market for deals. It is often hard for individual investors to get a look in. At Alliance we focus on assets that deliver ongoing income streams for investors with the prospect of capital appreciation in the longer run and invite individual investors to join us as we purchase, renovate, and sell these assets.
With Alliance, you can invest in medical office buildings alongside one of the top sponsors in the industry and in some of the most lucrative buildings in the country.
Related: There’s No Time Like The Present
Want to learn more about how you can invest in Commercial Real Estate? Visit Alliance Consolidated Group of Companies LLC today!
Embrace Opportunity
Commercial real estate crowdfunding creates a new opportunity for individuals who do not have time to own and manage real estate themselves. This lets you become a passive investor aligned with a seasoned, multi-cycle sponsor as part of our syndications. There are myriad reasons to invest in CRE. Whatever yours, it is important not to charge headfirst into the first opportunity that presents itself, but rather take a measured analytical approach and discuss it with an experienced advisor who can advise you on how to manage your portfolio.
POSTED BY
Ben Reinberg
Founder & CEO | Alliance Group Companies
Ben Reinberg is Alliance Group Companies' founder and CEO.
Since 1995, Alliance Consolidated Group has acquired and invested in medical properties with net leases between $3 and $25 million across the United States. With decades of commercial real estate experience, we take pride in committing to meeting the goals of our Sellers, as we consistently and seamlessly adhere to successful closings.
