Commercial real estate (CRE) offers unique opportunities for investors seeking to diversify their portfolios and generate steady income. Unlike residential properties, commercial real estate typically involves the acquisition and operation of properties meant to earn a profit through rental income and price appreciation. Whether you are an experienced investor or just starting, commercial real estate can provide significant advantages that make it worth considering. In this article, we’ll explore nine reasons why investors should consider adding commercial real estate to their portfolios.

What is Commercial Real Estate?

Commercial real estate refers to properties that are purchased with the intention of earning income or capital gains. There are four major categories of commercial real estate:

• Multifamily: These are properties with more than four residential units, such as apartment buildings.
• Retail: These include shopping malls, grocery stores, and restaurants that house businesses serving consumers directly.
• Industrial: Properties used for logistics, distribution, or manufacturing, such as warehouses and factories.
• Office: Commercial office spaces used by businesses for their operations, ranging from general office buildings to specialized spaces like medical offices.

These commercial properties are typically leased to businesses (except for multifamily properties), providing a steady stream of income. Investors often specialize in one or two of these property types, but all share the common benefit of generating income through leases.

Nine Reasons to Invest in Commercial Real Estate

1. Cash Flow

One of the primary reasons investors are drawn to commercial real estate is the potential for steady income. Rents paid by tenants provide cash flow that can be used to cover operating expenses and debts. Any remaining profits are distributed to investors. For example, if a property generates $100,000 in income and expenses total $80,000, the remaining $20,000 can be divided among investors. This provides a consistent income stream, especially if the property is managed by professionals.

2. Diversification

Commercial real estate offers diversification within an investment portfolio. The performance of commercial properties often doesn’t correlate directly with stock or bond markets. This means that when stock markets experience volatility, real estate values may remain stable or even rise, helping investors hedge against downturns in other asset classes.

3. Tangible Asset

Real estate is a physical asset, unlike stocks or bonds, which exist as pieces of paper or digital entries. Many investors find comfort in owning tangible assets they can physically see and manage. Real estate also provides intrinsic value, as it is a resource that can be used or rented out, giving it a practical and long-term utility.

4. Tax Benefits

Commercial real estate ownership offers several tax advantages:

• Pass-Through Taxation: Typically, commercial properties are held in a Limited Liability Company (LLC), which allows profits to pass through to investors without being taxed at the entity level, reducing overall tax burdens.
• Capital Gains Tax: When a property is sold, the profit is taxed as a capital gain rather than ordinary income, which typically results in a lower tax rate (up to 25% for long-term capital gains compared to up to 37% for ordinary income).
• 1031 Exchange: This allows investors to defer capital gains taxes when reinvesting proceeds from the sale of a property into another like-kind property, allowing for tax-deferred growth.

5. Appreciation

In addition to regular cash flow, commercial properties often appreciate in value. The key factor in this is Net Operating Income (NOI), which is the rental income minus operating expenses. Investors can increase a property’s value by increasing rents, reducing expenses, or both, directly impacting the NOI and thus the property’s market value. Additionally, favorable market conditions, such as a drop in cap rates, can further drive up property values.

6. Hedge Against Inflation

Real estate tends to perform well in inflationary environments. As inflation increases, property values and rents typically rise as well. By increasing rents, property owners can ensure that their income keeps up with inflation, which protects the real value of their investment. However, it’s important to note that inflation can also lead to higher interest rates, which may make borrowing more expensive and slow down the market.

7. Leverage

Commercial real estate allows investors to use leverage, meaning they can borrow money to finance part of the property’s purchase price. This can amplify returns, as investors use borrowed funds to control larger properties with relatively small amounts of their own capital. For example, if an investor buys a $1 million property with $250,000 of their own capital and borrows the rest, their return on investment can be higher, as they are leveraging the debt to generate additional income.

8. Yield Potential

Commercial properties can offer attractive yields, which is the income generated relative to the property’s value. Since leases typically increase over time, investors may see increasing yields as rents rise with inflation. This makes commercial real estate a strong option for those looking to generate predictable and growing income streams.

9. Capital Preservation

Real estate, especially certain types of commercial properties like grocery-anchored retail centers or long-term leased office buildings, offers a relatively low-risk investment with stable returns. For conservative investors seeking to preserve their capital while still earning income, these properties are a solid choice. These lower-risk investments are more stable and can function similarly to bonds, providing consistent returns without significant volatility.

Ways to Invest in Commercial Real Estate

If you decide that commercial real estate is a good fit for your portfolio, there are several ways to get involved:

• Direct Purchase: Buying a property outright allows full control over decisions but requires significant capital and time management.
• REITs (Real Estate Investment Trusts): REITs offer a more hands-off approach, allowing investors to buy shares in a portfolio of commercial properties. This provides exposure to real estate without the need for direct property management.
• Syndications: In a syndication, a group of investors pools their resources to purchase and manage a commercial property. This allows for joint ownership and profit-sharing.
• Crowdfunding: Real estate crowdfunding platforms allow individuals to invest smaller amounts into commercial property deals, making real estate accessible to non-accredited investors and diversifying their investment options.

Conclusion

Commercial real estate is an attractive investment class due to its potential for income, appreciation, and diversification. It offers tax advantages, serves as a hedge against inflation, and allows for leverage. Whether you’re seeking long-term growth, steady income, or capital preservation, commercial real estate can meet a variety of investment objectives.

As with any investment, it’s important to conduct thorough due diligence to ensure the investment aligns with your financial goals and risk tolerance.