Why Invest in Commercial Real Estate?

February 07, 2018

Why Invest in Commercial Real Estate?

Why Commercial Real Estate?

It’s a question that we receive every day. Why should I invest in commercial real estate? There are hundreds of other opportunities where an investor can put their money. Stocks, bonds, startups, crowdfunding, options, cryptocurrency, lending – you get the picture. But why should you invest in commercial real estate? Even if you don’t know much about the industry, you probably know more than you think. In today’s post, we’ll outline the reasons why investing in real estate is seen as a smart, reasonably safe, investment.

A Physical Investment

If you bought $50,000 into the latest startup that focuses on IT cloud development, could you see your investment? Sure, maybe a website with a few glitzy features, but where can you see your money being put to work? If you buy one Bitcoin worth $10,000 (but probably $8,000 by the time you finished reading this post), do you know what exactly you’re buying? You can’t hold a Bitcoin. It’s not something you can feel or even see.

Commercial real estate is different. To date, Northstar has completed over 120 deals across the United States. One of our latest projects is a retail development just west of Denver, called Gateway. Every month you can see the progress on the development of the property that’s located in Golden, Colorado. You can physically see the progress from month to month. Your money is helping provide construction workers with jobs. Your money is helping walls literally get built. Your money has an impact from start to finish. Few investments are like this – commercial real estate is something you can touch and feel – it’s a tangible asset. It won’t evaporate into thin air, like a number of stocks. Not only is having a physical building good from an investment perspective, but it also gives investors peace of mind. If a building or structure is delayed, then investors can actually see what’s happening. Consequently, if you can see once-barren land turning into physical structures – then you’ll feel pretty good about where your money is going.

A Hedge Against Inflatio

Inflation is one of those words that will take you back to your Economics 101 class in college, that maybe you forgot about. In short, inflation is a rise in the price of goods or services, while the purchasing power or currency is falling. The good news is, real estate is able to be a hedge against inflation. The value of your asset – whether it’s a residential building or commercial building – tends to increase over time. This is very rare, because the value of many major goods tends to not increase over time. Sure, the value of baseball cards, wine or art may increase, but think of other goods like clothing, computers, or cars. The second you drive your car off a dealer’s lot, you’ve lost 20% of your money, and you’re probably not getting that back. However, real estate is different.

A house you paid $100,000 for in 2008, could be worth 50%, 80%, or 100% more! There are a couple of few reasons for this – limited land in desirable locations, the sheer amount of effort and time it takes to build a new asset, wealthy people or investors moving to new cities, and neighborhood enhancements by state and local governments and the cost of the materials increasing due to inflation. Whatever the reason may be, real estate’s value tends to increase over time, and even with stock market corrections in 2000, or deep recessions like 2008, the price of a property will usually continue increasing.

Additionally, if you own a property, annual rental rates tend to increase each and every year. Nearly all rental contracts have a clause that allows for annual increases which are in line with the Consumer Price Index (CPI) or some other metric. This again is another way that real estate is able to adjust for inflation.

Short Term and Long Term Holds

At Northstar, we’re very pleased that the average hold period for our commercial real estate investments is 2.7 years – by industry standards, it’s a pretty quick turnaround on your investment. However, different investors have different investment styles. What I mean by that is, some people prefer flipping a new property and making a quick buck, whereas others like to invest capital in a long-term fund that distributes dividends every month.

The beauty of commercial real estate, is that no matter your risk preference, there are always options for you. If you want to have a long-term hold of 10 or 20 years with monthly, quarterly, or annual dividends, then look into investing in Real Estate Funds, or Core assets. These two options give investors relative safety (of course this always depends on the market), not a huge amount of upside, but also, not tons of risk. Think maybe, of an 8-10% annualized return.

If an investor is searching for a hold period of less than 4 years, and is willing to accept a decent or substantial amount of risk, then investors should look to Value-Add and Opportunistic developments. These types of assets might be vacant lots that will soon house an office park, or a dilapidated structure that’s in need of a huge make-over. Major financial institutions tend to avoid these assets because it’s not worth their time. However, smaller and mid-size developers tend to lick their chops at these opportunities. Building a new asset in a relatively young market gives developers and investors the opportunity to achieve returns as high as 25% or 30% annualized, with a 2-4 year hold period. Once the asset is stabilized and cash-flowing, the original developer typically has the opportunity to sell the building to another owner – hopefully for a strong profit. But again, it’s important to note – these types of properties tend to have more risk than funds or core assets.

Commercial real estate is all about learning the industry, and understanding your risk profile. By directly investing in commercial properties, you need to take the information on the development and run your own due diligence. Don’t be afraid to ask or over-ask questions. This is your money, and you have a right to know where it’s going. Ideally you will find a development, asset, Fund, or REIT that is a good fit for you.

This post was written by Northstar’s Director of Equity, Danny Mulcahy. If you would like to learn more about Northstar, available investments, or current assets, then please contact him at danny@northstarcp.com