Benefits vs. Risks in the World of Commercial Real Estate

Commercial real estate is an asset and investment class that can be both personally rewarding and put you on track toward building long-term, generational wealth.

Four property types fall under commercial real estate: office, industrial, retail, and multifamily. These are income-producing properties purchased to earn profit through rent and value appreciation.

But the benefits of commercial real estate aren’t limited to income. So let’s dive into some of the incredible benefits – and of course, the risks – of commercial real estate investing.

Benefit 1: Tax Benefits and Bonus Depreciation Benefit

Did you know that commercial real estate can help you save money on taxes? Deductions and bonus depreciation can offer tax breaks while an asset appreciates in value. For example, the interest paid on a loan is recorded as a cost and therefore deducted from income.

Additionally, bonus depreciation is an incredibly powerful tool that can be used to offset income. Bonus depreciation allows taxpayers to deduct the cost before its “recovery period”. Eligible items include personal property and many building components. Bonus depreciation can help commercial property investors save thousands. 

Benefit 2: Cost Segregation Studies

Depreciation in commercial real estate is not limited to the straight-line method, which depreciates the value of a structure evenly over the deemed recovery period of 39 years. A cost-effective way to maximize your tax advantages is ordering a cost-segregation study. These studies break down the components of a building and assign recovery periods, allowing owners to claim depreciation on each component independently. Fixtures with shorter lives can be depreciated at an accelerated rate, resulting in significant tax advantages.

Benefit 3: Multiple Types of Returns (CoC & IRR)

Cash-on-Cash (CoC) and Internal Rate of Return (IRR) are different metrics used to analyze an asset’s performance. CoC considers cash flow from a single year in relation to the total cash invested in the asset. IRR takes into account all cash flow throughout the entire period the investment is held.

These metrics can be excellent tools for gauging a project’s viability and comparing potential investments. In addition, we use them to quantify decisions and summarize an asset’s short-term and long-term potential.

Benefit 4: “Forcing” Appreciation Benefit

Value appreciation of an underperforming asset can be “forced” higher by increasing the property’s NOI. This represents an attractive advantage to investors. NOI can be increased by either reducing operating costs or increasing income.

Benefit 5: Diversification

Diversification is a vital element to reducing risk and building long-term wealth. By only holding your assets in stocks or your primary residence, you’re holding a highly concentrated portfolio. Instead, mitigate your risk by diversifying your portfolio with commercial real estate.

Benefit 6: Protection Against Inflation

Commercial real estate has long been identified as a hedge against inflation. Rising inflation increases consumer prices, which therefore drives rental prices upwards. As a result, commercial real estate investors often benefit during periods of high inflation.

Benefit 7: Control of Lease Escalations

Lease escalations are included in commercial real estate leases, allowing the landlord to increase the rent as stated in the disclosed timeline. Each lease will have set periods in which rental increases can be implemented. These rent rises increase NOI and ultimately increase the property’s value.

Benefit 8:  Tangible Asset

Unlike investing in stocks or cryptocurrency, when you invest in commercial real estate, you’re invested in a tangible asset. So even in unlikely circumstances of a severe market decline, that asset will remain, and its value will likely recover.

Risk 1: Market Risk

No matter the investment type, including commercial real estate, you’re always at the mercy of market changes. Therefore, asset selection and management are vital to investment success.

Risk 2: Regulatory Changes

Regulatory changes that impact either an asset directly or the current tenant can impact investment return and profitability. Examples of regulatory changes could that could impact an investment’s profitability are property zoning changes, rent control laws, new laws that impact a tenant’s businesses, or changes to building code requirements.

Risk 3: Macroeconomic Conditions

When significant macroeconomic shifts occur, they can impact real estate prices through consumer confidence or demand. Therefore, it’s essential to think carefully about the possible impacts of macroeconomic changes before choosing to invest.

Risk 4: Cost (High Barrier to Entry)

Purchasing commercial property, even small assets, comes at a hefty price that creates a seemingly impossible barrier to entry. Syndications offer a passive alternative to active investing with a significantly reduced capital requirement. Investing in commercial real estate can be made easy by working with a skilled team who does the heavy lifting while you enjoy the reward. Find out more about how to invest with RxREI by registering for our free investor portal.

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