Commercial Real Estate Investments
Real estate makes investors money. Technically, real estate investment is the spending on real property assets that produces an economic return. There are a multitude of investment options that allow direct and indirect investment in both debt or equity based real estate assets.
Equity investments can range from direct ownership of an income property, to ownership of publicly available shares in a Real Estate Investment Trust (REIT). Investors can also invest in real estate debt by directly holding a mortgage on a property, or investing in commercial mortgage backed securities (CMBS).
Investors in real estate can use financing to acquire real estate. The price of an attractive investment property may exceed the amount an investor is looking to invest. In investment real estate, an investor can borrow money to finance the difference between the amount of initial investment and the full purchase price of the investment property. The investor is effectively leveraging his or her initial capital investment. The financing can in turn leverage the investor's returns.
Whatever real estate investment option an investor chooses, the performance of the investment fundamentally depends on the performance and ability of the underlying income property to produce returns. The four primary ways an investment property can generate returns for its owner are through:
Cash Flow - Income Properties generate cash flows through rents and other income sources from operating the property.
- Tax Advantages - Direct ownership of income properties allows for deductions against taxable income and opportunities to defer taxes.
Equity Building - An owner's equity in real property builds as principal is paid down through loan amortization if the property is financed.
- Property Value Appreciation - There is the possibility the property will increase in value over time.
The operating cash flows from income properties are primarily generated from rental income. Tenants pay rent to the property owner of an apartment building or commercial building, typically on a monthly basis. The total rents generated by the property are its gross income. The total rent and profitability of a property generally drive investment value and hence the monetary size of the investment.
From an investors perspective, its important to understand the cash flows and rental income in terms of risk, size, timing, and management burden. To address these issues, the investor needs to know several things including:
- Lease term and expiration, rental rates, and payment timing
- Creditworthiness and total number of the tenants
- Rental market drivers
- Property condition and market suitability
Real estate investments also offer numerous tax advantages that differ from other investment classes. Investment property owners may be able to deduct depreciation as well as expense interest, taxes, insurance, and management fees. Capital gains may also be deferred through the 1031 Exchange process.
Real Estate Investors can also build equity through investment property ownership. Private capital investors often use a mix of equity and debt to acquire investment real estate. As principle on a loan is reduced as payments on a commercial mortgage made, the investors equity in the property increases.
Real estate values fluctuate over time. Supply and demand for investment properties, the ability to increase rents, inflation, or other external forces may act to increase property values. This means there is the possibility the property can appreciate in value at the time of sale. However, an investor should keep in mind that nobody has a crystal ball and nobody has the ability to fully ensure a specific future outcome.
Real estate investors are diverse and so are the investment opportunities available to them. They must assess each opportunity in terms of risk, size, liquidity, management demands, and holding period. Although there are many ways to invest in real estate, it is the ability of the underlying property to generate returns that is at the foundation of real estate investment. Investment properties produce returns through generating cash flow, providing tax advantages, equity building, and market value appreciation.
With a general overview of real estate investing, it's time to look more specifically at the different property types. Apartment buildings, retail stores, office buildings, and industrial warehouses have unique characteristics that distinguishes them as investments.