Caleb Richter, CEO of MyEListing.com.
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Investing in commercial real estate offers attractive alternatives to stocks and bonds. Similar to residential real estate, commercial real estate (CRE) ownership offers a steady tenant-driven income stream and the future opportunity to sell for a profit.
If you’re considering adding CRE to your portfolio, you have several options, most of which don’t require you to buy an entire property yourself. There are other methods that allow you to diversify into CRE without a large cash outlay.
Here I introduce three popular CRE investing strategies along with details of their main pros and cons. I’ll start with an established method that is especially popular: real estate investment trusts or REITs.
Contents
1. Real Estate Investment Funds
Commonly abbreviated to REIT, a real estate investment fund is a company involved in the ownership or financing of real estate. These companies offer shares on the major stock exchanges, which can be found by their symbol just like any other stock. The ARMOR Residential REIT Inc. share can be found, for example, with the symbol ARR. REITS are also structured like mutual funds and ETFs.
REITs are considered ideal for beginner investors as most do not require a large initial investment. They’re easy to buy – if you’ve ever bought a stock, you won’t have a problem with a REIT. Some 401(k)s offer one or more REITs to their members, so you may be able to diversify and add REITs to your retirement portfolio.
There are different types of REITs. Beginners are advised to research the most popular varieties: equity and mortgage.
Equity REITs own income generating properties such as malls, warehouses, apartment buildings and hotels. Tenants pay rent to the REIT, which is a determining factor in the value of a REIT. Some equity REITs invest in a certain type of real estate, which is good news for investors optimistic about those properties.
Mortgage REITs take a different approach. They invest in real estate mortgages and mortgage-backed securities, earn income by borrowing at short-term rates, and invest the borrowed money in mortgages that pay higher interest rates. Instead of rental income, this type of REIT generates interest income.
REITs have their own pros and cons. Here are some positives:
• REITs are ideal entry-level CRE investment products.
• Since REITs pay out a minimum of 90% of income and earnings as dividends, they can exceed the dividends paid by other stocks.
• REITs are quickly tradable.
And here are some negatives:
• Some REITs may charge high fees.
• Market volatility can negatively impact the value of a REIT.
• REIT dividends are taxed as ordinary income. This can result in higher tax bills for investors with sizeable holdings.
If you plan to finance a larger investment, you may prefer to partner with other investors and finance larger purchases. These groups are called syndicates.
2. Commercial Real Estate Syndicates
While the word “syndicate” might make you think of a villain in a Mission Impossible film, it is popular with investors willing to put a larger claim into one or more properties. CRE syndication allows investors to consider larger projects, especially those that require a large down payment. A syndicate can demand that all investors are accredited: In general, this is limited to members with an annual income of $200,000, although other factors may apply.
Each syndicate is led by a sponsor who identifies potential purchases, arranges financing and finalizes the acquisition. The sponsor may also enter into leases and collect rent. Other members of the syndicate usually play no role in managing CRE purchases. This can be seen as an advantage or a disadvantage depending on your personal view.
Since networking is a popular method of forming new syndicates, you may want to attend CRE themed events and increase your visibility to like-minded investors. One possible drawback of syndicates is that the laws regarding these vary by state. These can be especially challenging for new investors. In general, a syndicate requires the help of an attorney.
Do you want to raise your sights? If you are willing to buy a commercial property yourself, either as an investment or for your business, this investment has its own benefits.
3. Ownership of commercial real estate
While this gives you the most control over your investments, it also brings with it significantly more responsibilities. Ownership may be your best bet, especially if you are renting an office or warehouse space for your business. Finding the right commercial property can be the ideal location to expand your business. You can earn extra income by renting out vacant space.
Purchases for investment purposes is a different approach. If you don’t have basic property management skills, consider working with a CRE broker who can help you make offers and manage prospective tenants.
Whichever route you take, there are a few things to keep in mind:
• Commercial mortgages generally have a higher down payment requirement; 30% discount is not uncommon.
• Loan terms may be shorter.
• Qualification rules are generally stricter.
• Your purchase can provide you with a number of attractive tax benefits. Consider discussing these with a professional tax advisor or CPA.
If you want to know more, you can consult your bank or a real estate agent who specializes in commercial real estate.
Your CRE investment options
If you’re still in the research stage of CRE investing, you may prefer the REIT route. Shopping for this is easy and can be done online. Your initial funding can be just about any amount you want, and you can buy/sell REIT shares as easily as most people.
Investors who want to be directly involved in the purchase of one or more CRE properties and who are willing to make a larger investment may prefer a CRE syndicate. While the rewards may be higher than REITs, the potential risks are greater.
If you are confident in your investment choices or want to take your business out of a rental, purchasing a commercial property may be best for you.
The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice on your specific situation.
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