When I was on a three-year bicycle expedition around the globe, I was on a tight budget. I averaged about $7,000 per year in expenses. This works out to be less than $20 per day. Granted, we are talking about 2009-2012 dollars, but that’s still very snug by most travelers’ standards.
Hotels in pricy Western countries were out of the question. As were most restaurants and even campsites. I went for a week without a shower in the hot summertime of southern France, camped in an unfinished shopping mall in the south of Spain during a torrential rainstorm in the winter, and only used free campsites with no showers in Japan.
Those were the days that, in hindsight, I would have been far more comfortable with even a modest degree of passive income. I had read “Rich Dad, Poor Dad” during my university years, and the seeds had been planted. Yet, I had not taken any action toward financial independence. Had I been financially free with some steady passive investments, perhaps the bicycle trip never would have ended, and I would still be pedaling the dusty, wild roads of Mongolia or Tajikistan to this day. Or I may have been too comfortable to pull off such a trip in the first place.
Regardless of these introspections, knowing what I know now, I firmly believe that passive commercial real estate investment is the best investment vehicle for most people, especially those with an IRA or 401(K). And here are some reasons why (in no particular order).
1. Taxes
Because the IRS has very favorable depreciation rules for real estate investors for the reason that they provide things like housing or productive space, investors (as opposed to flippers, lenders, and real estate agents) can legally pay little or no tax on the investment income and even defer capital gains tax through vehicles such as cost segregation and bonus depreciation, a 1031 change, or deferred investment trust when it comes time to sell or trade up.
2. Recession Resistance
Did you know that the foreclosure rate of commercial real estate assets during the 2008 Great Recession was infinitesimal compared to single-family housing?
That’s partly because as people lost their homes to foreclosure, they still needed housing. So even while a recession may cause an increase in evictions, the vacant apartments will be filled by those who lose their homes or downsize from a more luxurious apartment. And for self-storage facility owners, it was boom time. There were so many people reducing their space but not their collection of worldly possessions that storage facilities performed better than average.
Another aspect of commercial real estate that helps weather recessions is that it is valued differently from single-family housing. Commercial properties are valued based on a multiple of their net operating income (NOI), similar to how a business is appraised. Houses are valued based on average comparable sales and market price-per-square-foot, a more free-floating, arbitrary methodology.
During a recession, there is often less competition for single-family housing purchases. This drop in demand and the likelihood of an increase in foreclosures causes an increase of supply and steady downward pressure on values.
Since commercial properties are valued based on NOI, if the NOI stays stable or even increases during a recession, the value will likely not be adversely affected. That goes for at least multifamily, self-storage, and mobile home parks. More risky assets like hotels and retail are more likely to suffer.
3. Inflation Hedge
The U.S. Dollar has lost 95% of its value in the past 100 years. This is mainly because more U.S. Dollars are printed each year. Over time, your savings will lose buying power as inflation erodes the dollar’s value.
There are several ways to hedge against inflation and even outpace it by allocating your money to suitable investment vehicles. Real estate values, in general, have outpaced inflation in the long term, even though the values may fluctuate in the short term.
4. Risk-Adjusted Return
The reader might conclude that we have a fair tolerance to risk based on our past adventures. Be that as it may, we are relatively risk-averse when protecting our principal.
That’s why we love commercial real estate. People often believe that taking on more considerable risks is the only way to secure a high return. While this may be true in the stock or bond markets, there’s not such a strong correlation in the world of real estate investment.
Although there are many variables to consider, generally speaking, the ratio of risk and return with commercial real estate investment is unmatched. Expect returns that beat the broad index funds in the long term, with far less volatility.
5. Stabilized Cashflow
Have you ever heard of “mailbox money?” How would it be to see a handsome check in the mailbox* every month regardless of what’s happening with the economy or the stock market? And that, without having to unclog tenants’ toilets at all hours.
*Note that we normally use ACH direct deposit these days, but you get the idea.
6. Passivity
Once an investor has done due diligence on the syndication deal and the operator, he or she can sit back and enjoy the returns. Of course, we recommend scrutinizing the quarterly reports as well, but beyond that, you only need to relax and focus on the more essential things in life, like family and hobbies. Many new real estate investors fall into the trap of owning a portfolio of rental houses only to find that they have created a full-time property management job for themselves. If you like the sound of that, great. But for most of us, life is too short.
7. It’s a Basic Human Need
What are the necessities of life? Food, clothing, and shelter. Mobile home parks and multifamily properties provide basic human requirements. Although self-storage is not at the top of Maslow’s Hierarchy of Needs, we know that, as a culture, we are pretty attached to our stuff, and letting go of a unit full of prized possessions is, as a rule, not in the cards.
8. Forced Appreciation
Instead of hoping and praying for market appreciation in commercial real estate, we force it. How do we do that?
Remember that the value of a commercial property is based upon net operating income (NOI) rather than comparable sales? That means that we can boost the value simply by increasing the NOI.
One way to accomplish this might be to raise the rents to market rate. Another way might be to decrease the vacancy rate from 15% to 5%. There are many ways to add value to a commercial property, simply by increasing profitability. Sometimes, it’s a straightforward process; other times, it takes some creativity.
9. Undersupply
According to weareapartments.org, the USA needs 328,000 apartments to be built annually through 2030 to meet the demand.
Most metropolitan areas do not have enough development to accommodate the increasing demand for rental housing. Building prices are high and continue to rise. Thus, it’s likely that vacancy rates will continue to be low, and rents will continue to go up in the years to come.
10. Excellent Returns
Your savings account is probably yielding less than 1%. Your stock portfolio may have yielded an average of 6-8% over the long term, with many peaks and valleys that may have made your life an emotional rollercoaster.
How does a safe 15% yearly return sound? Too good to be true?
Well, it’s not. That just so happens to be a plain vanilla projected return for a value-added commercial real estate syndication from most operators. Of course, you must do due diligence to ensure that the operator is experienced and trustworthy and that the underwriting is conservative.
But we will leave those instructions on performing those due diligence activities for another blog post.
Conclusion
While we can’t tell you whether or not a passive investment in a real estate syndication is suitable for your portfolio, for the above reasons, it’s an excellent bet for most. Primarily if your retirement account has performed less well than you had hoped. So, we encourage you to learn more about this exciting realm of the investment world. Real estate has created more millionaires than any other asset class. And it can do the same for you.
If you would like to know more or are ready to have us add your name to our investor list, then please don’t hesitate to schedule a call with us so that we can help you achieve your goals. If we are not a good fit, we will try to point you in the right direction.
Disclaimer: The opinions conveyed in this article are provided for educational purposes only and should not be interpreted as an offer to buy or sell any securities or to make or contemplate any investment.