5 Reasons You Should Have Commercial Real Estate in Your Portfolio
Commercial Real Estate
Commercial real estate investments generally offer regular income that can be higher than typical yields on dividend stocks and bonds. Stable income can provide protection and diversification against the volatility of the financial markets and commercial real estate generally does not move in sync with stocks and bonds.
Commercial real estate investments such as the ones offered on RealtyMogul.com’s platform can provide an array of tax benefits to a real estate investor. Deductions related to depreciation, interest expense and other items can shelter or defer taxes on cash distributions. For example, current cash flow will often be less than the total depreciation and interest expense creating a return similar to a tax-free bond. However, in most cases, these benefits will be recaptured upon a sale of the property. Depreciation recapture is taxed at 25% while the remaining profit or capital gains is taxed at the long-term capital gain rate.
For example, an office building is purchased for $1,000,000. Of that, $250,000 is allocated to the land. The basis for depreciation is $750,000. If a real estate investor owns the property for 5 years, about $135,000 can be depreciated. Upon a sale after 5 years, an investor’s basis will be $615,000. Assuming a sale price of $1,500,000, the gain will be $885,000 ($750,000 gain plus $135,000 in depreciation). The $750,000 will be taxed as a long-term capital gain and the $135,000 will be taxed at the depreciation recapture rate. We are not tax advisors and we suggest that you discuss your specific tax situation with a professional.
For investors worried about how inflation will affect their portfolios, direct investment in commercial real estate can be a great hedge against the effects of inflation. According to a report by TIAA-CREF, “If inflation emerges, investors in commercial real estate will likely withstand it according to the historical performance of the asset class. Over five-year holding periods historically, commercial real estate returns outpaced inflation nicely. Over short term periods, commercial real estate returns have been modestly correlated with inflation demonstrating their ‘inflation hedging’ capacity.”
A major benefit of direct commercial real estate investment is the ability to place debt on the property which can increase the purchasing power of each dollar of equity. This in turn increases the total potential returns of the property, which also increases the risk. A simple example is a $1,000,000 property. Typically, only $250,000 of equity will be required with the balance funded by debt. If the property is then sold for $1,250,000 in 1 year, the cash return would be 100%. If the property was purchased with no debt, the cash return would only be 25%.
Pride of ownership is something that cannot be valued. With direct commercial real estate investment, an investor actually owns an asset that they can see and feel. It is something that they can point out and say “I own that!”