While the stock market appears to have the glamour and action, with prices rising and falling by the hour, it’s really quality real estate investments which have the power to perform during any market condition, bull or bear. People further argue that stocks and bonds have the edge over real estate investments, thanks to their liquidity, but that theory of liquidity simply doesn’t hold water, if you don’t mind the pun.
Granted, liquidity can be of value for those investors uncertain about their decisions. Liquidity is your escape hatch when an investment sours or no longer meets your financial needs and goals. Unfortunately, all too often, by the time you are opening that escape hatch, the bad news has hit the streets which is reflected by a plummeting price. Then the game becomes about getting out before others.
This is not at all the game which commercial real estate investors prefer playing. They are more into winning from step one, and continuing to cash in on their astute choices month in and month out, thanks to the reliable rental and lease revenues which commercial real estate is capable of generating.
The Three Reasons You Need Commercial Real Estate
While every investment offers certain benefits, when you compare the reasons why astute and experienced investors regularly seek out commercial real estate properties as investments, you will better understand the logic behind making this type of commitment. And you will likely find yourself more excited and motivated to pursue commercial real estate because, as you will see, those benefits really pay off!
Reason #1: Tax Advantages
Whenever you earn dividends on stocks or interest on bonds, you are required to declare those earning on your tax return and pay taxes on them, according to your tax bracket. With tax brackets as high as 37%, you could see a good third of your investment income from stocks and bonds go right into the pockets of your local and federal government.
With average stock yields offering an unexciting 2.22% annual return and bond yields of 5% per year, knocking off a third of those returns brings you down to returns of 1.40% and 3.15% after taxes, but before inflation. With US inflation on pace to run 2% per year for the next few years, your stock returns don’t even keep up and the bonds are barely staying ahead of the inflationary curve. (By the way, the reason bonds offer higher yields is that there is minimal or no upside growth potential on the bond principal; annual interest payments are what bondholders rely upon.)
In comparison, when investing in quality commercial real estate investments, you can shelter most, sometimes all, of your real estate revenue. In fact, in the early years, if played right, you can save taxes and get a tax-free income stream with a paper loss on your commercial real estate investment; that is simply something a stock or bond cannot do!
Reason #2: Reliable Revenue
When you buy stock, you are buying shares of a company which works to generate profits for its shareholders. Unfortunately, those profits are beyond your control; if the CEO of the company whose share you own is awarded a hefty “performance” bonus, that comes out of your pocket in the form of reduced dividend payments. Ironically, that same CEO, when the company doesn’t produce profits or dividends, is still paid a sizable salary and often still gets a bonus!
If you view a commercial real estate venture as a type of business, which has employees and generates revenue, the powerhouse making your money is not a highly-paid executive or group of employees, but instead is a tangible property. Better than bonds, where interest rates are fixed for long terms of time, real estate rental agreements and leases are typically structured as short term contracts, which regularly renew with increases in rental or lease payments. Even long term commercial property leases often factor in regular lease increases to reflect anticipated inflationary increases.
So not only are you sitting on a reliable revenue stream, but it adjusts for inflation, often notching up faster and higher than the actual cost of living is rising.
Reason #3: Superior Growth
While stock prices can fluctuate wildly, particularly during economic periods of uncertainty, commercial real estate investors are blessed by a quieter, less volatile, marketplace. As a matter of fact, stock prices rarely reflect the actual value of the company, but infers value based upon potential, promises, and hopes. In other words, the stock market is often pushed about by emotions, which causes dramatic rises and falls of fortunes beyond the control of the investor.
It’s just the reverse when it comes to commercial real estate investments. Because there are not daily postings of the “value” of a commercial real estate investment (which reflects more than the intrinsic values of the property), determining a realistic and fair value of a property is based upon formulas, not feelings.
Two formulas in particular remain popular and reliable methods for gauging the value of a commercial property:
Capitalization Rate
Also called a “cap rate,” this determines actual investment return (as a yield percentage) by dividing the net annual income by the original purchase price. For instance, a property for which you paid $1,000,000 and is generating a net income of $75,000 per year would have a 7.5% cap rate (75,000 divided by 1,000,000 = 0.075, or 7.5%).
If you held that property for 20 years and your net income rose to $150,000 per year, your cap rate (or investment return) is now 15%. However, if you decide to sell this property at that original 7.5% cap rate, your property would list for $2,000,000, or a doubling of your investment.
Gross Rent Multiplier
Also called a “GRM,” this is a more simplistic approach to determining value, as it is based solely on gross rental revenues, without factoring in operating expenses to determine net revenue. For the astute investor confident about effectively managing commercial real estate operating expenses, purchasing on a GRM evaluation is an acceptable approach.
The formula for determining the GRM is simple: divide the asking (or purchase) price by the gross rental revenue, and the result is the GRM. If we use the same example as above, where you paid $1,000,000 for a commercial property, here is how you would calculate its GRM for that purchase price:
- We will assume that gross rental revenues run $150,000 (operating expenses of $75,000 produced the $75,000 net income in the Cap Rate example above)
- Since you paid $1,000,000 for this property, divide $1,000,000 by $150,000
- The result is 6.67, which is the GRM if purchased at $1,000,000
By the way, if you are a savvy investor and can negotiate a $900,000 purchase price, your GRM drops to an even 6.
The rule to remember is you want to purchase properties with the highest cap rate and/or lowest GRM.
Finally, as to future value. It is great to say your property is worth $2,000,000 on paper, but it’s unlikely you will find another solid investment capable of producing the 15% return you are now earning. While investors in stocks and bonds are usually trying to watch for a good selling point, with the phenomenal rate of return you receive, you have no motivation whatsoever to sell and get into “something better.” You already have the best investment with commercial real estate in your portfolio!
Commercial Real Estate Opportunities in Jackson, Mississippi
Savvy investors in America and around the world find the commercial real estate opportunities in Jackson, Mississippi both exciting and profitable. This state capital, with a population of under 200,000 citizens, offers beautiful commercial properties with exceptional cap rates, much higher than the national average.
At Speed Commercial Real Estate, Jackson is our own very backyard which we have worked assiduously and thoroughly for more than a decade and a half. As specialists in commercial property sales, we are also active managers of multiple properties, including office, retail, and industrial warehouse spaces.
For the discriminating investor demanding an above-average return with below-average risks in the commercial real estate sector, our expansive list of properties can very well meet your specific desires. Call us today and we’ll help you uncover a property gem capable of amazing income and growth returns.