Commercial real estate has always been an integral part of one’s investment portfolio, mainly because of the potential for high risk-adjusted returns when compared to other asset classes and diversification.There are several factors that contribute to the growth of the US commercial real estate market, despite fluctuating exchange rates and complex tax laws. Both domestic and international investors view the market as a safe haven for their capital, with an outlook of stability and sustainability.There are a number of current micro and macro level dynamics contributing to the strong investor appetite and benefits like cash flow, portfolio diversity and asset appreciation make this appetite increasingly strong.Why Invest in US Commercial Real Estate?Whether it is commercial or residential, any type of property can be an attractive investment opportunity. Commercial properties generally offer more financial reward than residential properties and if you follow the principle of long-term investing, higher returns can be earned compared to other debt instruments.Here are the top reasons why commercial real estate is attracting a broader investor audience to the asset class: 1. Attractive Risk-Adjusted ReturnsThis is one of the main reasons why both institutional and private sectors are pursuing real estate investments.Compared to stocks, bonds or commodities such as gold, real estate investment returns are quite attractive.According to The National Council of Real Estate Investment Fiduciaries (NCREIF) report, the annual return on commercial real estate investment in 2016 was 12.7%, which in turn had a positive effect on other key indexes such as the S 500, Dow 30 and Russel 2000.On a long-term horizon, the NCREIF has projected an average annual return of 8.8% for commercial real estate investment over the next 15 years which is 2% above the performance of the S 500 over the same period. 2. Cash FlowCommercial real estate investment is structured in a way that delivers steady cash flow with dividends that are distributed to investors on a monthly, quarterly or on an annual basis.Equity investments involve buying a passive, minority ownership stake in a hard asset such as an office, industrial or apartment building. The combination of high occupancies and rising rents delivers exactly what every investor strives for—a steady cash flow stream over time. 3. Ability to LeverageThe best way to build wealth is by finding a way to do it with the help of leverage. When it comes to returns from commercial real estate investment, leverage means that you can place debt on the property which can be higher than the initial equity investment.Although leverage will allow you to purchase more property with less money, your overall risk increases due to the leverage effect. 4. Asset AppreciationAnother great characteristic of real estate investment is that it typically increases in value over the long term.This appreciation can come from increasing rents or from a higher present valuation of a property than what was in the past. Investors also have the opportunity to increase their overall investment return by cashing in on property appreciation or recognizing the benefit of a capital gain once the property is sold.When property values rise and fall depending on the market cycle, timing the exit strategy is a critical aspect for maximizing investor value. 5. Tax BenefitsReal estate is one of the few investments that offers numerous tax benefits. And, the biggest tax benefits are the mortgage interest deduction and the depreciation deduction. Both areas can enhance your income stream by lowering your tax bill. The 1031 exchange also allows allows an investor to sell a property and use the tax deferred profit as a down payment on another property.Working with a tax professional is advisable so that you can avoid potential costly mistakes and maximize the tax benefits.Where are we at in the Current US Real Estate Cycle?There are many positive things that happened in 2017, which have had a direct impact on the US real estate market, which were not apparent in previous years.National prices crossed the previous peak of 2006, mortgage rates remained historically low and data suggests that more millennials are becoming homeowners.This is how the US Real Estate Cycle looks currently: 1. Prices Continue to Rise but at a Slower PaceThe later half of this year saw the largest rise in the price of real estate, recorded at an astonishing 5.61% national increase.Experts believe that the prices will continue to rise despite the slow sales growth because there is a significant increase in demand which is stronger than what it was at the same time last year.High consumer confidence along with a low unemployment rate, plays an important role in affordability trends which suggests there is not going to be an immediate reversal in rising prices. 2. Volatile Mortgage RatesThis has happened mainly due to the recent US Presidential Election. Following President Trump’s election, 30 year mortgage rates have gone up to 4% for the first time in 2 years but by historic standards they are still low.The increase in mortgage rates has been a combination of both euphoria and optimism over the President’s promise to lower taxes, but the realistic assessment from the experts is that rates will see an upward trend, but it will happen at a slower pace. 3. Improvement of Credit AvailabilityWith a promise of revoking the Dodd-Frank Act, the President has given the banks the opportunity to lend more freely to a wider range of potential buyers.Though not everyone is convinced that this type of lending will allow banks to operate more independently, transitioning government-controlled mortgage companies to private control has given the investors something to cheer for.All the above factors are positive signs that the sector is still growing and that there will be a rise in the construction of new commercial buildings and spaces, as prices continue to climb steadily.The current US commercial real estate market is between the expansion and hyper supply phase, as foreign investment into US multifamily properties has pushed the property prices exceptionally high, driving cap rates lower and therefore, on a national level, it has become more difficult for the average investor to find an attractive deal.The Approach that Investors Should Take to Make the Most of the Commercial Real Estate Market in 2018The landscape of the US commercial real estate market is ever changing and the ability to adapt is essential in recognizing the opportunities that lie ahead.Here are some areas that investors need to take note of, if they are looking to maximize value as well as growth. 1. Unlocking the Value of REITsMany traditional REITs today are trading well below their NAVs (Net Asset Value).Let us have a look at some statistics:As of July 26, 2017, the SNL US REIT Equity index was down 5.6% year-over-year (YOY) compared to the 14.2% rise in the S 500. Among REIT subsectors, retail and office REITs have been the most impacted with negative YOY returns of 25.5% and 7.8%, respectively. Overall, REITs are trading at a 4% discount to NAV, with regional malls trading at a historically high discount of 33.3%.Therefore, it is evident that a lot of value of the REITs has been eroded despite, commercial real estate (CRE) fundamentals remaining strong with positive rent growth, net absorption and stable vacancy rates across nearly all core property types.To unleash the value of REITs, investors should consider different approaches that will reinstate shareholder enthusiasm through critical assessment of existing corporate governance and communication strategies. 2. Real Estate Startups The Commercial Real Estate market is witnessing a significant growth of digital initiatives in recent years. Startups are constantly incubating new ideas as they continue to increase in size and services offered.Investors can choose startups to collaborate with based on the services they need and financing required. Investors can leverage online services and solutions to make key property related decisions, access capital by the use of innovative funding and use investing platforms that they offer. 3. Social MediaCommercial real estate investors should also use the different social media platforms as powerful tools for gathering information.With information coming from a multitude of sources on social media platforms, investors can make faster and more informed decisions on where to allocate their capital. There are many options and interfaces for investors to choose from, which will help with their due diligence process. 4. Generation Z AwarenessThis is an important area that many traditional investors forget when they consider investing in a project.The preferences of millennials have been unique and Generation Z is also gaining influence quickly. With most of them just graduating college, Gen Z is expected to reach 2.56 billion individuals globally by 2020.Therefore, giving special attention to the needs of this large market can give investors an edge over the competition.Best US Commercial Real Estate Sectors and Locations for 2018Even with the uncertainty of new regulatory rules and tax implications proposed by the Trump administration, commercial real estate investors can still find value in the current market.Let’s look at the US Commercial Real Estate Market Emerging Trends for 2018:Here is a list of the top US markets to watch in 2018, with Seattle, Austin, and Salt Lake City leading the pack.Image source: https://www.curbed.com/2017/10/26/16554900/real-estate-trends-housing-affordability-urban-developmentBased on 1,600 interviews with property owners, home builders, developers, real estate firms, investors and lenders, the Emerging Trend is a gold-standard look at where the commercial real estate market is headed.The forecast takes into account factors like overall cost, affordability, availability and construction labor along with the cost of infrastructure improvement where needed. The hot sectors are apartments, industrial space, assisted living, student housing and storage or warehouses.However, there is a less demand for office properties as more people are starting businesses and working from home. Apart from the condition and location, even in the hottest sectors, an effective property manager and availability of extra amenities can provide investors with an attractive investment.On the other hand, online shopping is the biggest challenge that the retail section of the commercial real estate is facing. One solution to revive the struggling sector is by making the malls more resort-like, where people can go to relax, eat and entertain themselves rather than just shopping.With more than 54% of world’s population now living in urban areas, there is a huge shift in global demography and the US is no exception. The demographic shift has given rise for a need to invest in urban and municipality planning and has helped in revitalizing and reinventing the formerly neglected parts of many cities.Whether it is a commercial housing project or construction of an industrial space, the annual GDP growth and employment growth shows that the commercial real estate sector is still an attractive asset class for investors who have the right balance of price, land cost, location and amenities.Image source: https://www.curbed.com/2017/10/26/16554900/real-estate-trends-housing-affordability-urban-developmentWays to Invest in Commercial Real EstateIn the past, investments in commercial real estate had been limited to the few who had the sufficient resources and knowledge, but now there are more ways than ever before to get involved in commercial real estate investing.Here are a few ways the average investor can access commercial real estate investing: 1. Real Estate Investment Trusts (REIT)A real estate investment trust is basically a mutual fund of aggregated real estate assets.Owing shares of a REIT is as simple as owing stocks in a company but here you have a major advantage. While most publicly traded companies have to pay corporate income taxes on their earnings, REIT’s earnings are non-taxable, as long as 90% of the earnings are distributed to the shareholders in the form of dividends.Owning shares of a REIT also comes with the benefit of diversification because you spread your risk across a variety of properties, located in different geographical areas. 2. Limited PartnershipsThis is an excellent method for the investor who is looking for a passive investment without the responsibility of handling day-to-day operations.There is a general partner who sources the investment, manages the property, obtains financing and makes decisions on the issues of leasing and mortgage.And there is the limited partner who provides the equity capital and owns only a certain percentage of the deal. This percentage consists of the cash flow and a share of the profits when the deal is sold.When limited partnerships are typically structured around 2 to 10 investors, the strength of the partnership depends solely on the degree of communication between the partners.This method is a good choice when you are not looking to take an active part in the management of properties and are comfortable with the capacity of the limited partners to vote on major issues. 3. Direct InvestmentIf you have the luxury of time and are willing to spend a lot of it managing your investments, you should consider purchasing a commercial property yourself.This requires extensive research and a deep understanding of the local market. An equity contribution of 20 to 30% of the total purchase price is usually required initially and if you are patient, direct investment is a more effective way of generating returns, where you, being in total control are the sole beneficiary of the profits.ConclusionCommercial real estate investors should realize that the industry is facing constant changes and they need to embrace these changes rather than view them as challenges.The dimensions of value creation and growth are changing rapidly with the advancement of technology and the unique preferences of future generations.Investors need to to collaborate both internally in terms of function and externally in terms of resources and capital to maximize their ability to achieve an attractive risk-adjusted and sustainable return.Knowledge of the current market and the current business cycle are paramount in order to strategically allocate investment capital. If you do your homework and are patient, the commercial real estate market still has plenty to offer investors.
August 20, 2019 0 Comments