Why Invest in Commercial Real Estate?

By Beacon Staff

The real estate market has picked up substantially. Our business and commercial markets have decided what our local climate should be and have decided to move on from our past situations and keep pushing forward to create new business opportunities. There is new evidence of growth in the building industry in both the residential and commercial arenas. Local buyers are commenting on the amount of inventory in all sections of the real estate market. Depending on an individual’s interest, the time to purchase is at hand with historically low interest rates and sale opportunity.

Why would you want to look at investing in commercial real estate as opposed to other investment options currently available? I can think of four main reasons why I would rather invest in real estate than other options:

  • Real estate is transparent
  • Real estate is a tangible asset
  • Returns are usually greater than alternative investments
  • Tax liabilities are lower with real estate investments

The one part that I have always loved about real estate is the transparency of the investment as well as being able to go by the building and say, “yeah, I own that.” Instead of owning a tiny piece of a company that you have no control over, you own a building where you know the tenant, lease terms, projected incomes over time and current value of the asset.

I have recently been finding real estate investment opportunities in the valley that have an internal rate of return in the 12 to 15 percent range over the term of investment. That means you make 12 to 15 percent on the money you invest and another 6 to 9 percent leveraging the bank’s money. Not a bad deal!

When looking at the effective tax rate on the income from a commercial real estate investment, it is much lower than other investments because of interest and depreciation write-offs. In my opinion now is the time to take a good look at investing in the Flathead Valley. Prices are low but activity has really picked up in the last six months. I believe we have hit the bottom and are starting to rebound and will see prices start to escalate.

Once the decision has been made to use real estate as an investment, there are specific ways to hold your investment dollars accountable and choose the best vehicle for your individual purchase. Wouldn’t you be interested in making a great return in your real estate investment? How about a way to compare one investment opportunity to another and get a true “apples to apples” comparison? Then you need to be able to calculate the Internal Rate of Return (IRR) of the investment. Calculating the IRR will determine what your true return on investment will be over the entire term of the investment.

Capitalization rates and even cash-on-cash returns are only a first-year ratio and not a measure of investment potential. This is why the IRR is such a powerful tool for the real estate investor. It looks at the original investment, terms and conditions of the financing, cash flows over the term of the entire holding period as well as the anticipated sales price at the end of the investment. It then discounts all of the future cash flows back to the original investment date to figure out your true annual return for the investment. You can even factor in increased vacancies, capital improvements, rent escalations and expense escalations that might occur at a future date.

At the end of the day what you have is an annualized return for the money invested over the term of the investment. You can then use the IRR of the real estate return and compare that to any other alternative investment you might be considering.

Dave Girardot is a broker with West Venture Real Estate, LLC

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