The Benefits of Investing in Commercial and Industrial Real Estate
By: Mike Lorelli – Senior Vice President – Commercial Asset Management, High Associates Ltd
Investing in commercial real estate offers many benefits and could serve to diversify an investment portfolio that is based solely on stocks and bonds. While commercial real estate typically describes all income-producing real estate such as commercial, industrial, retail, and multi-family residential, our focus in this article will be on commercial and industrial properties.
Before making a direct investment in real estate, it is important to understand the market where the investment is located, including competitive properties, rents, occupancy, and the area’s general economic health. An investor should also understand the costs of ownership. Unlike stocks, real estate is an active investment and may require additional capital investment over the hold period.
Commercial property investment: Stable and long-term income
Owning either commercial or industrial real estate offers many benefits. First, unlike residential properties, lease terms tend to be longer, typically three to 10 years or more. This provides an investor with a longer, uninterrupted income stream and potentially less turnover and vacancy loss than a residential investment. Buildings and/or tenant suites are also more customized for the business and its operations, resulting in less turnover than other types of real estate.
Lower Operating Burdens
The lease structure for office and industrial real estate is typically triple net meaning that most of the cost of ownership is passed back to the tenant. Expenses such as taxes, insurance, maintenance, and repairs would be reimbursed by the tenant. Structural issues such as roof replacement or parts of the building envelope typically remain the investor’s responsibility.
Commercial property investment serves well as a diversification to a stock portfolio since it helps mitigate risk against stock market volatility and serves as a hedge against inflation. Most commercial and industrial leases have annual escalators, which can increase the investor’s income to offset inflation. Rising rental rates also offer the potential for real estate appreciation, assuming capitalization rates remain steady. This appreciation will increase the investor’s overall return when the property is sold.
Tax Benefits of Commercial Real Estate Investing
The final benefit of owning investment real estate is the tax benefits derived from ownership. The most well-known benefit is depreciation, which allows investors to depreciate the acquisition of the building based on a set schedule. Additionally, there are options for accelerated depreciation and cost segmentation, providing faster opportunities for depreciation based on the useful life of certain building systems or elements.
Mortgage interest expense is also deductible, and depending on the investment, there could be tax credits or incentives based on the property’s location, energy enhancements, and other government initiatives.
Finally, there is a tax benefit for like-kind exchanges, commonly referred to as a 1031 exchange. If successful, an investor can defer capital gains associated with the sale of a property if invested in another commercial property within the defined period of time. To fully understand all the potential tax benefits of an investment, it’s advisable to consult an accountant or a tax professional.
As the real estate landscape continues to evolve, it's important for investors to stay informed not only about tax policy and asset performance, but also about shifting transactional frameworks. Explore how real estate commission structures are changing — and what it means for buyers and sellers.
REITs Offer Liquidity and Lower Entry for Passive Investors
Is commercial real estate a good investment for everyone? It can be — but investing in industrial real estate and commercial property can be challenging due to the substantial initial investment and the ongoing capital requirements. Additionally, the lack of liquidity associated with this type of investment may deter some potential investors.
If this is your situation, but you like all the other benefits of investing in commercial real estate, then investing in a real estate investment trust (REIT) may be a good option to explore. They offer liquidity and the ability to invest with a relatively small amount of capital.
According to the National Association of Real Estate Investment Trusts (NAREIT), the average annual returns from REIT investments, considering both income and appreciation, range from 8 to 12 percent over the long term. These returns will vary based on the asset type, geographic footprint, and the current economic cycle. As with any investment, research should be done before investing in a REIT.
When evaluating REITs, key factors to consider include historic return performance; markets invested in; types of assets included in holdings; performance of their portfolio such as occupancy, tenant mix, and lease rates; dividend payment policy; quality of management team; and performance to peer REITs.
Investing in commercial real estate: Expert guidance makes a difference
Whether investing directly in real estate or through REITs, real estate can serve as a valuable addition to a stock portfolio, helping to diversify and mitigate risk while potentially enhancing overall returns.
If you are interested in an individual property, you should consider selecting a buyer agent to represent your interests before entering into a real estate transaction. A qualified agent should have strong local market knowledge regarding lease rates, cap rates, vacancy ratios, and product demand for the specific asset class.
FAQ: Why Invest in Commercial Real Estate
1. What are the main benefits of investing in commercial real estate?
Long-term income, inflation protection, tax advantages, diversification, and triple net leases make commercial real estate an attractive asset class.
2. Is commercial real estate a good investment during inflation?
Yes. Many leases include annual rent escalators, helping property owners keep pace with inflation and increase returns.
3. What are the tax benefits of commercial property ownership?
Depreciation, interest deductions, 1031 exchanges, and possible tax credits or incentives based on location or energy upgrades.
4. What’s the benefit of investing through REITs?
REITs offer easier access, better liquidity, and passive income, especially for those without capital or time to manage physical property.