With traditional capital markets trying the patience of investors, and savers being penalized by historically low interest rates designed to help recapitalize bank balance sheets, I often get questions about the role of commercial real estate as an alternative asset class for investors. Here, then, are 6 reasons to consider adding commercial real estate to your portfolio:
1. Non-correlation to stock and bond markets
Non-correlation simply refers to the fact that real estate does not fluctuate in value in tandem with stock and bond markets. True, bond yield movements (an inverse relationship to price) can impact real estate prices as they provide benchmarks for bank lending rates. However, there is not a 1:1 correlation to those markets and this is where commercial real estate can provide enhanced diversification as an alternative asset class. It can provide a hedge against declining asset prices and represents a longer term "support" to capital values.
Businesses and retail tenants can generate income for you from leases. After operational expenses and the mortgage are paid, there hopefully is residual cash flow to you, the owner.
Depreciation represents a tax write-off of some or all of your income which reduces your overall income tax burden.
4. Equity Growth
As your mortgage balance is reduced, this represents an accumulation of equity for you. The tenants in your property pay down your loan for you.
Overall appreciation of your property occurs as rental income goes up, as the market assigns a highler value to your property income and as the value of the land goes up. Particularly in an inflationary environment, commercial property can provide an excellent hedge as rental income will rise with inflation.
Although bank credit is tough to access in today's market, traditionally leverage means you can borrow a substantial amount of your purchase price to buy the property. Leverage allows you to control a large property for a small percentage of the value. For example, if you buy a property for $4, you may borrow $3 and add $1 of your own. If the value of the property goes up to $5 (a 25% increase,) and you sell it, $3 goes to the bank and $2 goes to you. That's a 100% rate of return to you on a 25% increase in value of the underlying property. That's a very simplistic example...but you get the point!
Consider commercial real estate as an alternative asset class to stock and bond markets. It can be a valuable component of your overall asset allocation strategy.