When building a long-term investment portfolio, many people focus entirely on residential properties and overlook the potential that commercial properties have. Commercial properties such as office buildings, multi-unit apartment complexes, retail stores, and more are valued parts of any community and have the potential to deliver robust returns.
Commercial properties are riskier than investing in residential properties and often require a larger investment upfront. Here are some reasons to consider adding commercial properties to your portfolio.
Inflation Hedge
Inflation is a significant concern for investors in today’s market, especially as inflation rates around the world have been on the rise. Commercial properties can serve as a hedge against inflation especially if the existing lease structure includes annual rent increases for tenants. Additionally, property values tend to go up when inflation happens, which increases the strength of your commercial property investment.
Potential for Income With Strong Returns
Commercial property investments can provide a source of passive income for the long term. These properties strive to provide steady monthly paychecks, which makes them a choice for long-term retirement investment.
Additionally, commercial properties tend to provide stronger returns than residential properties or other popular investments. For example, commercial properties typically provide returns of 6% to 12%, while returns for residential properties are typically less than 4%.1
Passive Management
Many commercial properties offer passive management structures, which make them an option for those who do not want to take a hands-on approach to their investment. This means that many aspects of the investment are handled by a financial professional rather than the investors themselves. These are also long-term investments and tend to be less volatile than a portfolio of stocks and bonds.
Triple Net Leases
Commercial properties also typically come with fewer maintenance expenses than residential properties because they use triple net leases. With a triple net lease, the tenant pays all of the expenses on the property, which include maintenance, insurance, and property taxes. This means that the owner is only responsible for the mortgage when applicable.
Many large retail tenants prefer triple net leases because it gives them more control over the property. This is potentially beneficial for everyone - the tenant has the flexibility to maintain the property to their standards, while investors have fewer expenses to take on.
Tax Advantages
Commercial properties can also have some tax advantages when compared to other forms of investment. In most cases, investors will need to pay capital gains taxes when selling a real estate investment. Real estate investors can avoid this by using a 1031 exchange.
With a 1031 exchange, investors can use the proceeds from the sale of one property to invest in another without paying taxes. The exchange must be completed within a certain period of time to avoid capital gains taxes. 1031 exchanges are a viable option for both commercial and residential properties.
When it does come time to pay capital gains taxes, there are ways for investors to reduce their tax burdens. Depreciation deductions can reduce overall tax burdens. In the US, commercial buildings depreciate over a period of 39 years, which means that you can take a depreciation deduction every year during that time period.
Overall, commercial properties can be a way to diversify your portfolio and potentially generate very strong returns. There are many different types of commercial properties on the market, so you can choose an option that best suits your risk tolerance and investment needs.
1Past performance is not a guarantee or indication of future results.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status.
Programs that depend on tenants for their revenue may suffer adverse consequences as a result of any financial difficulties, bankruptcy or insolvency of their tenants.
