The 6 Top Objectives for Real Estate Investors
Generally, commercial real estate investor’s objectives include some or all of the following six:
- Investment portfolio diversification;
- Utilization of the tax advantages of real estate ownership;
- Profit generation;
- Regular cash flow;
- Inflation protection; and
- Building wealth for retirement.
The Real Estate Investment Advantage
As you likely already know, investing in commercial real estate has advantages.
Over time, real estate investing has proven to be relatively stable compared to other investments. Though the market will fluctuate, it is historically not prone to doing so rapidly, or without warning.
There are few other opportunities to leverage your cash as much as one can with real estate. For example, how many shares can you buy in the stock market with $100,000? Unless you have a margin account with your broker, if you said $100,000 worth of shares, you would be correct. However, how much commercial real estate can you buy with $100,000? Certainly you could buy $100,000 worth, but you could also buy $200,000 worth of real estate, if you secured a mortgage for 50% of the property purchase price. Similarly, you could buy $300,000 worth of real estate, with a mortgage of 66% of the purchase price, and so on.
With a well leased property your tenants will pay rent sufficient to cover your required mortgage payments (ideally with a surplus!).
In most markets your investment will grow. Either through a general appreciation in values resulting from inflation in the marketplace, but also through growth of equity through the regular pay down (“amortization”) of your mortgage.
You have greater control over your investment (compared to say, equities), as you can directly improve cash flow by making property improvements, securing financially stronger tenants perhaps on longer lease terms, increasing rents, or reducing expenses. You can also acquire more favorable financing terms, once you educate yourself on the various options available to you.
What’s your take-away here? The top benefit of commercial real estate is the potential to generate income. This can take the form of rent paid by the occupants, to the building owner, or perhaps from income from an operating business to a building owner, in the case of an owner-occupied building.
Are there risks associated with owning commercial real estate? As with any investment, there are potential downsides which also relate to income generating capabilities, or more to the point, lack thereof.
Over-leveraging (taking on too much debt, or debt that is too high priced) is potentially problematic. In periods of upward pressure on interest rates, excessive debt re-priced at a higher rate upon mortgage renewal, can quickly reduce or eliminate positive cash flow. We have been in a protracted period of stable and low interest rates. Rate fluctuation is possible, and indeed likely.
Paying too much for a property can obviously be challenging. The amount of financing you will be able to obtain will be dependent upon the value of the property as estimated by the lender. They will often rely on the valuation as determined by a real estate appraiser. If your lender’s estimate of property value falls short of the price you’ve paid, you will need to adjust your financing expectations. Likely you will need to inject more of your own funds (equity). Buy right, and do not rely on price/value inflation to bail you out of fundamental real estate errors! The implication is obvious. Avoid overpaying! While easier said than done, avoid emotional attachment, do your homework, and be prepared to walk away, rather than overpay.
You make money when you buy real estate, not when you sell real estate!
The real estate market is not as liquid as, say, the stock market. A property sale prompted by a need to liquidate an asset quickly can lead to a less than advantageous sales price.
Management skills are important. A proactive approach to tenant relations, property upkeep, and maintenance, will lead to better results.
Political or economic influences beyond your control can lead to changes in the economic viability of the community within which you’ve acquired a property. For example, the closure of a plant that is the primary economic driver within a community, could lead to job losses, and population stagnation or decreases. This has a direct impact on commercial real estate viability. Do your analysis before you buy.