The Benefits of Passive real estate investing
Commercial real estate investing has many benefits that other investment vehicles, like stocks and bonds, wish they had.
As an investor, you will not only receive passive income and appreciation from the property, but also tax benefits, risk diversification, increased buying power, and more.
The benefits of passive real estate investing are abundant.
So long as you research the individuals or groups with whom you plan to invest, you will watch your passive income and wealth grow exponentially while taking advantage of all of the ancillary perks, as well.
Here are a few of the benefits of investing in commercial real estate:
Increased Buying Power Through Leverage
Leverage may just be the best benefit of investing in commercial real estate.
It increases your buying power.
It helps diversify your portfolio.
And it decreases your total exposure to a single project.
Leverage is when you utilize debt (borrowed capital) to make an investment.
How Leverage Works
Per the example above, instead of placing $100,000 cash into a single property, you can leverage that investment to purchase five $100,000 properties with a 20% down payment.
You would place debt on a property with the expectation that the profits from owning and operating that property will be greater than the interest you would accrue from your lender.
Sure, you will incur expenses with a mortgage that you wouldn’t have to deal with otherwise, which will decrease the project’s cash flow. However, since your down payment will be significantly less, you will increase your cash on cash returns.
Put simply?
Every dollar you invest has a higher return. Who wouldn’t want that?
Scaling Bigger, Faster
And as a passive investor in a commercial real estate project, you can pool your money together with other investors to purchase an even larger, more stabilized asset than any of you could likely afford or care to risk alone.
Depending on which type of investment you decide to make, you may not be required to sign as a guarantor of the debt. So only your initial capital will be at risk.
2. Risk Diversification
It doesn’t matter what you’re investing in - you need to have diversification. And investing in commercial real estate can provide you with meany different ways to diversify your investments.
How can you diversify your commercial real estate portfolio?
different Asset types
There are many different types of commercial real estate. And not only are there different types, but different real estate classes within those types.
There are many real estate investors that refuse to invest in stocks, bonds, or other investment vehicles because they can spread out their risk across a wide range of properties.
Multiple Tenants
Unless you’re purchasing a single-tenant net investment, you’ll likely have multiple tenants within your chosen property.
The more tenants you have paying you rent, the less risk you’ll have if one of them moves out or defaults on their lease payments.
More income streams = less risk.
Different investment strategies
There are many different ways you can passively invest in commercial real estate.
You can take a more “stocks and bonds” route by purchase shares through crowdfunding, REITs, and real estate ETFs, or you can be a limited partner, hard money lender, or even hire a property management firm to handle the day to day of your operations.
Invest in different markets
Depending on the type of investment strategy you take, you may be able to invest in commercial real estate across the country.
If one market falters for whatever reason, you don’t have all of your eggs in one basket and can rely on the remainder of your portfolio to support that struggling asset.
invest in multiple properties
Just like taking a multi-tenant strategy, you can spread your investments across multiple properties in order to diversify your risk.
Maybe you own a single-tenant net lease in Louisville, a mid-rise office complex in Atlanta, and a strip center in Dallas.
There are an abundant amount of different types of passive investments you can make as a commercial real estate investor.
3. Forced Appreciation
That’s right. You don’t have to wait for comps and your neighbor’s property to sell at a higher price to bring more value to your property.
You can actually force that appreciation. Here’s how:
NOI-Based Value
In commercial real estate, a property’s value is directly correlated to its Net Operating Income (NOI). By increasing the net operating income that your property produces, you can significantly increase the value of the real estate to any potential investors.
Why is commercial real estate valued this way?
It’s an investment! And investors purchase the buildings for the cash flow that each investment offers based on a capitalization rate (cap rate). These cap rates are the net return an investment will give to the investor if they paid all cash for the property.
How Cap Rates Work
For example:
If you paid $1,000,000 cash for a piece of commercial real estate and it had an NOI of $100,000 per year, that would give you a 10% cap rate.
Investors use this cash-based metric because every investor group’s financing, or lack thereof, will vary depending on each group’s strategy and goals.
You have far more control of your investment’s value in commercial real estate than you do in just about any other investment vehicle.
4. Investing With Seasoned Professionals
Learn from someone who has already been there.
The knowledge a seasoned investor will bring to the table about how to approach your project, as well as how not to approach it, will be critical to your success as a new commercial real estate investor.
Become the Money Partner and Learn
One of the best ways you can learn about commercial real estate is by passively investing with an established, experienced investor. This person or group needs to be someone you can trust.
Especially since you’re going to be placing hard-earned capital with them.
Look into their track record. Review their recent deals. I even recommend you call their other investors and lenders to see what their experience has been working with your potential operator.
Choose Your Role: Active vs. Passive Investor
Investing with seasoned professionals reduces your chances of having a failed deal as a first-time passive real estate investor. And if you’re looking to learn how to do these deals on your own, you could take a more active role in the project (but that’s for another article).
I know many successful investors that started their career this way.
If you’re too busy or don’t necessarily care about running a new venture, this is certainly the way to go. The most work my investors have to do on our projects is read the quarterly reports.
And even then - at the end of the day, they just want to know that their money is working for them, they don’t care or worry about the day to day operations of the investment.
Taking this path will definitely allow you to now only learn more about the industry, but also grow your passive income.
5. It’s A Tangible Asset
Commercial real estate is a physical, tangible product.
You can see it. You can touch it. You can even live or work out of the investment you’re making.
Even some of our clients do just that - they operate their businesses from the property and allow that company, which is their active income, pay down the mortgage and cover all expenses associated with the property.
We’ll cover more on the tax advantages there next.
There’s Value in the Income and the Asset
Unlike stocks, bonds, and most of your other investment options, commercial real estate has value not only in the income and cash flow it throws off, but also the land itself and the property’s improvements, such as the building and infrastructure.
In a worst case scenario where your income falls to zero because either the tenant has defaulted on their lease or has moved out, you still have valuable assets to fall back on, which certainly protects your downside.
Tangibility Offers Stability
Commercial real estate is also a relatively stable asset, as it can offer housing (apartment complexes and mobile home parks), services (retail or office space), or storage and manufacturing (industrial warehouses).
Because of these factors, commercial real estate often does not fluctuate and experience the roller coaster swings that the stock market will.
Not to mention the peace of mind you’ll have by being able to drive by the asset.
6. Tax Advantages
The tax advantages provided by commercial real estate investing are incredible.
Not only do you benefit from the income, appreciation, and stability, but you will also receive many tax benefits.
Write Off Interest Payments
As a property owner, one of your first benefits is your ability to write off the interest payments you make on your mortgage.
So, not only are you using someone else’s money to buy commercial property, but you can also write off their profit for providing you with that capital.
It’s a Depreciable Asset
Commercial buildings also begin depreciating the minute that you acquire them. The asset may not be “physically” depreciating in terms of its usability or aesthetics, but every day the building does get older and “less valuable.”
The IRS provides a 39-year depreciation schedule for commercial real estate, but you can also accelerate this process by performing what’s called a cost-segregation study.
Essentially, you get a write-off just for owning the property!
Everything Else you Can Write Off
Other write-offs include any renovations, maintenance, ongoing upgrades, or other expenses related to owning and operating the asset.
If you decide to owner-occupy the property, meaning you actively run a company out of the premises, then you’ll find additional tax benefits.
The rent and maintenance expenses paid for by your business will be a tax write-off to that business and the income you collect as the property owner (I recommend the property ownership entity being entirely separate from the business, but that’s a conversation for your CPA) is taxed at a much lower rate since it’s considered passive income.
If you decide to sell the investment, you’ll benefit from capital gains tax, which is significantly lower than most investors’ ordinary income tax, and you can even exercise a 1031 exchange into another property without paying taxes at all.
7. Passive Income!
Everyone needs a little passive income in their lives.
It’s probably the reason you decided to pursue commercial real estate, right?
Passive income is money that you make from an investment or other venture that you don’t actively have to work to receive.
Put Your Money to Work For You
The opportunity to build up more passive income from your investments than you make during your day job is one of the most attractive aspects of investing in commercial real estate. You place your capital into a deal and your money works for you.
In my opinion, commercial real estate is the best vehicle for increasing that revenue stream because tenants will pay down your mortgage while the property appreciates in value and you can justify hiring a property management firm to take care of the day to day operations. Sit back, manage the manager, and collect your checks.
If you invest properly, you’ll get paid while you’re on vacation. You’ll receive income while you sleep. And eventually, you may even get to a point where you don’t have to actively work again. Unless, of course, you intend to continue building your portfolio.
And not only does passive income help you achieve financial stability in your life, it’s taxed at a much lower rate, up to 20% of your income, compared to ordinary income, which is taxed up to 37%!
Paying close to half your active income tax rate will certainly help you build wealth faster.
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About The Author:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors as a board member for the Real Estate Investors of Nashville. Learn more at www.TylerCauble.com
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