Why Invest in Commercial Properties?
You should invest in real estate? Because it is a building block to real Wealth.
“Most Private sector wealth is in Real Estate” – well, maybe not – numbers at this scale are difficult to comprehend. According to the Feds, TOTAL WEALTH is about $100 Trillion (yes Trillion), with real estate composing somewhere between 40-50% of this depending on how the stock market (stocks, bonds & mutual funds – the other part of wealth) is going. A lot of the real estate is in housing, but more than half is said to be in commercial real estate.
Just a quick look at skylines and large and small towns show the vast holdings in real estate. Every family estate from the early Europeans has real estate holdings as the core to their wealth. I always marvel while walking thru New York at the vast number of buildings, 90% of which are held by families versus institutions or public entities.
Is commercial real estate for everyone – no. Many studies have found that most people should have 10% or less of their wealth tied up in real estate. During the 80’s a lot of research was going on as to whether Real Estate was a separate “Class”. Bottom line, the answer was yes, and it has proven to have a significant “Beta” (reacts differently) than other types of investments in portfolios. The general thinking amongst Pension Plans and Large Family Offices is that a portfolio weighting of 15%-25% in Real Estate Assets is a goal. Studies have found that AUM(large assets under management) have a higher weighting with 25-30% of their net worth invested in Real Estate.
Real Estate Returns come from:
- Cash Flow
- Debt (both for the positive effect on Cash Flow and the pay-down “forced savings” of amortization of the debt)
- Tax Considerations – Depreciation, and the favorable treatment of Capital Gains
- Asset Appreciation – either thru just plain 0ld inflation or the increase of cash flow from increasing rents.
- Building of equity creates a “leveraging” affect in growing your business
- Inflation hedge. As inflation increases so do rent and so do costs of reproducing assets. One of the major things I look at is how does the cost of the target investment property compare to the cost to replace it. Leases can throw this relationship out of wack, as a lot of NET LEASED properties are two or three times or more the cost of reproduction.
According to a 2017 study by Taurus Model Group, Five-year Average Annual total Returns per Property type. https://gallery.mailchimp.com/6d9e9dd6ea121405b160d1c45/files/b0389b45-57f0-40a5-bc8e-c5855f911548/Taurus_Modal_Group_Market_Report_2017_11C.pdf
These rates seem high to me, and are over the last five years which has had an unprecedented growth after an unprecedented downturn.
However, I target 8% in my analyses. Steve Steppe, long term friend and Principal at RREEF, one of the largest early Pension Fund Advisors in Real Estate, said he could divide, multiply, and factor anything by 9. I always thought 10 would be easier, but oh-well.
9% is also a magic number – Rule of 72– any number compounded by 9% per year over 8 years doubles. 8% roughly doubles in 10 years