Introduction
Like many people today, you’ll recognize this financial predicament.
You have savings that you want to invest in or already have money in the market. However, your broker or adviser has only ever discussed two asset types with you: stocks and bonds (and maybe a few others, if you’re fortunate).
If you’ve never considered the prospect of investing in commercial real estate, it’s in your best interest as an investor to compare this distinct and lucrative asset class with the more known stock market.
While practically everyone knows the stock market as an asset class and a possible location to deposit investment funds, many investors have never been introduced to commercial real estate as a feasible investment choice.
So, let’s analyze what makes commercial real estate distinctive, why you should invest in it, and how it can help you develop your wealth and access gains you would have otherwise missed in your investing career.
Not Always Are Complimentary Perks Offered
Many people participate in the stock market due to their companies’ 401(k) matching schemes. In most cases, there is an annual contribution cap beyond which you may continue to give, but your donations will no longer get matched in full. Typically, access to these matching programs has restricted to traditional financial markets (stocks, bonds, etc.).
For this persuasive reason, numerous individuals have stock market exposure in their financial portfolios. However, corresponding job advantages are not always accessible.
Perhaps you are self-employed and operate a company. Or maybe you’ve reached the yearly 401(k) contribution limit that your company will match, and you want to diversify your holdings.
If you are in this situation, you may consider diversifying your portfolio with commercial real estate.
Commercial Property Gives You More Control over Returns
Sometimes, investing in the stock market is equated to gambling. While not strictly correct, the parallel reveals an essential truth: the casino and the stock market are venues in which money is gambled, with little individual control over the eventual consequences of profits or losses.
Improve Profitability
In contrast, commercial real estate has several chances to affect investment profitability actively. You may raise the profitability of your investment property by making many improvements.
Numerous aspects, including landscaping, interior, and exterior painting, and improved lighting, may increase the value and profits of your commercial real estate investment.
Additionally, you may increase your real estate profits by doing your due research on an investment beforehand and ensuring that your company objectives for the property coincide with the financial trends and reality of the region in which you are investing.
For example, if you live in a region with a significant elderly population, it may make sense to invest in a similar retirement home or property. The objective is to align your investment with the market’s requirements.
Stay Away from Hidden Fees and Transaction Costs
If you’ve spent most of your financial life investing exclusively in the stock market or other conventional asset classes, you may not have given much thought to transaction expenses and fees. However, they soon pile up, so it is essential to examine them more attentively.
As specific fees are only expressly indicated in the tiny print, let’s take a brief look at the most typical transaction fees and expenses you may pay to your broker without even knowing it.
1. Trading Costs – Trading fees are often known as “commissions” in the financial business. They had paid your broker in exchange for their help establishing and electronically executing your desired deal.
2. Brokerage Fees – Your broker may charge you for various services related to maintaining your investment account. Among many others are yearly fees, monthly costs for account administration, and penalties for account inactivity if you don’t trade for a lengthy time, and expenses to transfer or terminate your account.
3. Advisory Charge – Numerous brokerages also provide advisory services for an extra yearly charge, which had often determined as a percentage of the size of your account with the business.
4. Expense Ratio – Today, a lot of people participate in mutual funds and exchange-traded funds (ETFs), two stock market offshoots. Annual expense ratios had assessed by the mutual fund or ETF for the opportunity to possess, purchase, and sell shares of a particular investment.
Remember that these are just a handful of the most prevalent stock market fees and trading expenditures. You are probably paying far more expenses than you realize. It would be worth your effort to sift through your brokerage’s paper or electronic statements and break down the costs you pay annually.
Diversifying your portfolio via exposure to commercial real estate may be a very successful strategy for minimizing costs throughout the life of your portfolio. And this should be one of your long-term objectives across all asset classes.
Of course, commercial real estate investment comes with its own set of fees and expenses, but many of them may be written off during tax season or avoided via judicious investing.
Recurring fees may cost you tens or even hundreds of thousands of dollars over the course of years and decades, both in terms of themselves and when you consider the potential gains you might have earned if you had been able to invest that wealth instead. Remember to keep your prices cheap.
Tax Advantages Apply To Commercial Real Estate
Along with decreasing your yearly fees as much as feasible, another long-term objective for investors should be to minimize their tax burden.
Commercial real estate investment offers significant tax benefits that do not apply to stocks, bonds, and other comparable asset types. Let’s review them.
1. Depreciation – Depreciation was estimated using the IRS-established 39-year “useful life” standard for company property. For each year you hold the asset, you may deduct 1/39th of its entire cost for depreciation.
Depreciation is a particularly beneficial tax advantage because it is a non-cash cost: This implies that you accumulate considerable tax savings every year without paying anything for them.
When you sell the property, you will ultimately be required to pay taxes on all depreciation expenses already deducted: This has known as the recovery of depreciation tax. However, there is still a net gain since the depreciation recapture tax rate is often lower than other tax rates.
2. 1031 Exchange – Even if avoiding the depreciation recapture tax is not possible, it may get postponed by using a 1031 exchange. A 1031 exchange prevents you from paying capital gains taxes and depreciation recapture taxes when you sell an investment property in commercial real estate.
However, some instances had taken into account. The Internal Revenue Service only permits 1031 exchanges if the profits from the sale of the property got invested in a similar asset (also known as a “like-kind investment”). In addition, there is a 180-day time restriction for engaging in a 1031 exchange after selling the original property.
Many investors will buy and sell a property, then reinvest the earnings in a more significant, more lucrative venture: This had known in the real estate market as “trading up.”
When the IRS charges you capital gains tax and depreciation recapture tax on the sale of your property, it will have based on the original, smaller property. Multiple investors may do this, so the cumulative impact on your earnings can be substantial if you invest intelligently over time.
3. Interest Expense – The majority of commercial real estate transactions had funded through loans. When you acquire a commercial property, you may deduct the yearly sum of your loan’s mortgage interest from your earned income.
This may result in significant tax season savings, particularly in the early stages of debt repayment.
4. Your Recipients Will Receive Tax Advantages – In addition to the tax advantages described above, commercial real estate also imparts tax advantages on your dependents if you leave your real estate assets to your descendants or other beneficiaries.
If someone inherits and sells your property after your death, they will have the option to participate in a 1031 exchange, deferring capital gains and depreciation recapture taxes if they so choose.
In addition, if you inherit a business property, your successors will get a “stepped-up” basis: This implies that when they decide to sell, they will only pay capital gains taxes on the investment’s value at the time of inheritance.
If the property appreciates between the time it is gifted and the time it has sold, a “step-up” basis may be highly advantageous if commercial real estate got left to others in a will.
In Commercial Real Estate Investing, Insider Trading Is Allowed
In recent decades, insider trading has acquired broad negative connotations. The SEC defines insider trading as the purchase or sale of security while in the knowledge of critical, nonpublic information on the profit outlook or potential of the guard in question.
Insider trading has strictly prohibited in the stock, bond, and other traditional financial markets. It is penalized by imprisonment, often accompanied by penalties that surpass the value of the unlawful transaction, and occasionally by a term of limited access to or total exclusion from the financial markets.
Even celebrities such as Martha Stewart have been convicted and sentenced to jail time for it. Sometimes, the attractiveness and enticement of significant earnings might be overwhelming. Did you realize, however, that the commercial real estate industry not only legally permits insider trading but thrives on it?
“Insider trading” in commercial real estate is “trading on flawed knowledge.” And it is generally the basis of the finest offers.
After all, the basic notion is to acquire a property for less than it is worth because you see more potential or value in it than the current owner.
Perhaps you want to do upgrades and increase rents. Or maybe, based on your study, you want to transform the property into a restaurant or business that is highly successful in the region.
During the due diligence process, you have witnessed something about the property or the socioeconomics of the surrounding region that has convinced you that the building is worth more than what you are paying for it.
People need this investment assurance so much that they are willing to sacrifice their freedom in traditional investment markets to get it. However, insider trading is permitted and even promoted in commercial real estate.
Conclusions Regarding Commercial Real Estate
Diversifying into commercial real estate has several advantages, including tax advantages, more control over returns, and portfolio diversification.
And with choices such as online commercial real estate crowdfunding, the entrance barrier for this lucrative asset class is lower than it has ever been in the history of the world.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.