WHAT MAKES COMMERCIAL REAL ESTATE A GOOD INVESTMENT?
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There are many ways to invest. But the most proven way of obtaining high returns has been through commercial real estate. This is not just a recent phenomenon – it dates back to the founding of the United States. John Jacob Astor became America’s first millionaire through commercial real estate in Manhattan. And the fundamental reasons that commercial real estate is the #1 investment choice remain as true today as they were in the 1800’s.
One of the hallmarks of commercial real estate is that they are income producing. Unlike most stocks, which pay no dividends, commercial real estate is defined by its ability to pay out regular cash distributions. This is an extremely important trait, as it allows the investor the ability to have greater patience through recessions – since they don’t rely on the sale of the asset for income – as well as give greater security in covering problems that may come up along the way. With most stocks, the only way to realize any income is to sell the stock. With commercial real estate, income is achieved from the cash-flow of the property, regardless of a sale. In addition, commercial real estate has traditionally had the highest returns of any form of investment. While most stocks that do pay dividends are lucky to hit 3% distributions annually, and CDs, Treasuries and bonds paying as little as 1%, it is not uncommon for commercial real estate to pay out 10%+.
The ability to create massive wealth through capital appreciation is an even bigger part of commercial real estate than cash flow. It is not uncommon for commercial properties to increase significantly in value of time. In fact, commercial real estate has proven to be one of the greatest hedges to inflation of all investment types. One of the reasons is that rents increase with inflation, and commercial real estate’s value is built upon those rents. If the rents double, then the value of the property doubles – it’s that simple. Inflation also drives up the cost to build new properties, so the values of existing real estate go up to match those new values.
This is one of the most important reasons that real estate has proven to be such an outstanding investment type over time. Most commercial real estate is not purchased with 100% cash, but rather with maybe 20% to 30% cash down, and the rest is paid with a mortgage. This ability to buy assets that exceed your immediate cash available allows you to build wealth rapidly. This was the exact technique used by John Jacob Astor to corner the market on Manhattan real estate. Here’s how this unique attribute of commercial real estate works in real life. Let’s say that you buy a commercial property for $1,000,000, with $200,000 down and a $800,000 mortgage. Over time the rents go up 50%, and you then sell the property for $1,500,000. The net profit on the sale is $500,000. But instead of a 50% return on your investment, that $500,000 is a 250% return on your $200,000 down payment. Why are banks willing to make loans on commercial real estate and not other asset types. One of the reasons has been the exemplary performance of commercial real estate for hundreds of years. Banks are comfortable with commercial real estate values. Additionally, the values of commercial real estate are very rational – based on stable rents – while stocks are often irrational and have giant fluctuations in value, which scares banks. Because of leverage, investors are able to create much greater gains than any other form of investment.
Most commercial real estate is based on pretty basic needs, such as shelter (apartments and mobile home parks), basic sevices (retail and office), and storage (self-storage and industrial warehouse). While stocks often revolve around fairly complex business models that are often built on luxuries, commercial real estate is based on strong, perpetual demand. In addition, while stocks trade at price-to-earnings ratios (also known as P/E ratios) of up to 100 or more, commercial real estate rarely trades for P/E ratios of 10 or less – and the lower the P/E number, the lower the risk.
Most commercial properties have multiple tenants. This gives the owner some portfolio balance and diversity – they are not 100% reliant on just one tenant’s rent. For example, if you have a 100 space mobile home park – and one tenant leaves – the impact on the property’s finances is minimal. However, with a stock or bond, you are 100% tied to one business, and if it fails or does poorly, your investment is ruined.
Since the founding of our nation, commercial real estate has been the most profitable form of real estate. In fact, over 48% of all American millionaires made their fortune in real estate. With a track record of success, higher returns, and greater security, there’s no investment class as attractive as commercial real estate.