Last week we talked about the advantages of lending in commercial real estate. This week, we’re looking at the other side of the coin and exploring the benefits of owning commercial property.
Again, a short disclaimer: this conversation does not pertain to home ownership or residential properties.
I.D.E.A.L. — Five Advantages to Owning Commercial Property
I love this acronym because it fits in nicely with ownership advantages.
Income= Cash flow – expenses. Your property can produce cash flow that pays you each month.
Depreciation offers significant tax advantages on commercial properties. In theory, time erodes the value of an asset, but in real estate the opposite it often true – the value rises. Nevertheless, you can write off the property as a depreciating asset.
Equity is the increase in value over time, plus your tenant’s rent payment pays down the principal every month.
Appreciation in property value over time is typical in real estate. Particularly in steady areas (such as Birmingham, Kansas City, etc.), 3-4% appreciation per year is fairly standard.
Most real estate investments make more sense with leverage. With leverage you can buy more property, which helps you spread out your risk across different properties, markets, regions, and so on. Plus, you get all the depreciation of the property to offset the taxes.
Accelerate the depreciation of a commercial property to offset income
Commercial properties are usually scalable enough to do a cost segregation. A cost segregation allows you to depreciate certain components of a property over a shorter life span, such as 5-7 years. For context, in a straight line depreciation for a house, the lifespan is over 37.5 years.
Different materials in a property, such as electrical, plumbing, appliances and carpeting depreciate at different rates. For property as large as a small apartment complex or larger, a cost segregation makes sense. With buying a storage facility, we are absolutely conducting a cost segregation study, but it doesn’t make sense for every property. Cost segregation studies are costly and need to be done by a specialist
With more control comes more responsibility to move the needle forward
Owning the property comes with a great deal more of control. Depending on your knowledge and skills, you can force the appreciation of the property through simple additions and improvements.
Adding a washer/dryer to each individual apartment complex may cost $400 per unit up front, but by charging an extra $50-$100/month you can probably make that money back in 12-24 months. Cosmetic improvements, as well as management and security improvements to a property will help you move the needle up on property value.
The same can be said for owning a storage unit business. Essentially you’re buying an empty building shell and asking, ‘okay, what can I do with this property to make cash flow?’ You put in storage units and charge individuals to rent them. Suddenly, the net operating income doubles, triples and quadruples the property value, many times over. Again, if you’re skilled, and enjoy more control and involvement, there is value to be created.
With more involvement and activity, comes a greater return
If you are the one finding the opportunity, you deserve to make a bigger return – period. Per hour of work, you’re probably going to make less than a private lender, but with regard to overall return, you should be making more – otherwise, you’re doing it wrong.
If you’re the one taking the majority of the risk and finding the opportunities, make sure you are compensated appropriately.
Finding Opportunities vs. Finding Money
In 2008, people could not get loans – including investors, both private and traditional. That made finding money more important than finding opportunities to put money somewhere.
In today’s economy, finding opportunities are more important than finding money. Simply put: there is a good deal of money with no place to put it. As return rates on CD’s go down and more people are entering retirement age, people are pulling their money and looking for places to put it. People want to find opportunities to put their money somewhere, and as a property owner you can meet that need.
How active do you want to be?
All of this depends on how active you want to be.
If you want to be completely inactive and not do anything, walk your cash down to your local bank, buy a CD, get a 1% return and lose purchasing power. In five years time, you’ll be able to purchase even less with whatever money you put in the bank to begin with.
If you want to put in even just a bit of effort, you can find people who are doing opportunities and loan money to them and perhaps make 6-8% (or more, depending on how active you want to be as a lender).
Getting even more involved includes being the one to find opportunities and put opportunities together for investors. Here, you are more on the ownership and management side of things.
When You’re Ready, We’re Here
Want to find out more? Contact us here about investment opportunities for passive and consistent income.