A Doctor’s Guide to Commercial Real Estate Investment
There is no getting around it; medical burnout is real. Whether you’re an anesthesiologist, general practitioner, or a cardiologist, you probably don’t have much free time to keep up on the latest tech IPO or commodity crisis. However, this lack of time does not have to lead to a lack of ROI for your investment portfolio. There are several ways to generate positive, passive returns using commercial real estate, even if you’re busy working with patients or research.
There are plenty of investment vehicles available, so why should doctors invest in commercial real estate?
The right commercial real estate asset will generate returns while you’re busy working with patients, grabbing lunch with a friend, or even sleeping in your bed. As a high-income medical professional, your time is incredibly valuable- a passively managed commercial real estate investment saves you time while also potentially generating a substantial ROI.
A diverse portfolio is a healthy portfolio. Commercial real estate assets can give investors exposure to vehicles other than traditional stocks, bonds, and mutual funds- and the lower risk that comes with that additional exposure. Some commercial real estate assets, like multifamily residential properties, can even help your portfolio weather an economic recession, which is a major plus when the market contracts.
High Tangible Asset Value
Investments in real estate are backed by bricks and mortar. Stocks, mutual funds, and bonds are all more dependent on the whims of the market. Real estate assets offer a reduction in principal-agent conflict; in other words, the interest of the investor is less dependent on the competence and integrity of financial managers and/or debtors. This also holds true for listed real estate securities like REITs, which typically have regulations that require a minimum profit percentage be paid to investors as dividends.
As most physicians fall into the higher end of federal and state tax brackets, investments that offer tax reduction, deferral, or elimination are preferable to those without such benefits. Property depreciation allows investors to deduct the expected depreciation of a commercial property on their annual tax return.
In addition, commercial real estate income is not subject to FICA payroll taxes and is instead taxed as short- or long-term capital gains. There are many other ways to save on a tax bill with commercial real estate assets, including 1031 Exchanges, Opportunity Zones, Low Income Housing Tax Credit, and a plethora of state and local incentives for investing in the housing market.
Commercial real estate’s combination of tax benefits, passive income, steady cash flow, and property appreciation make it an attractive sector for physicians looking to maximize their portfolio returns without dedicating massive amounts of time to following the day to day markets.
Commercial Real Estate Tax Benefits Include:
Capital Gains Tax Rates
Tax Deferral/Tax Elimination via Opportunity Zones
Tax-Free Estate Transfer via 1031 Exchange
Local and State Tax Reduction
Low Income Housing Tax Credits
There are two ways to get involved in the property markets- active and passive real estate investing.
Active Real Estate Investing
When investors personally purchase properties to generate returns via cash flow or appreciation, they are actively investing in real estate. The type of property does not matter; it can be anything from a multifamily apartment building to individual single-family homes, to large retail and shopping centers.
The process of direct investing involves:
Searching online databases like Loopnet or 21st Century Commercial, or working with a broker or agent to find desirable investment properties that meet investor ROI and risk profiles.
Due Diligence on Potential Acquisitions
Evaluating a subject property, as well as its underlying business operations. Investors need to research the local and national market, the property type, and physically inspect the property in question with the help of an appraiser.
Most property investors utilize lender financing to acquire and/or upgrade commercial real estate assets. Direct investors are responsible for securing that financing by working with a loan officer or other capital lender provider. One issue with financing is the interest, which can significantly cut into your eventual return on investment. Choosing to invest in an investor-capitalized fund can dramatically lower or even eliminate interest payments over the life of the asset.
Acquiring/Managing the Property
Finally, direct investors are responsible for negotiating with sellers and closing the property deal, often with the help of an agent or broker. Once the property is added to the investor’s portfolio, they will also be responsible for day to day operations, finding tenants, upgrades and repairs, and a whole host of other duties that come with being an active landlord.
Passive Real Estate Investing
Many high-income professionals do not have the time or inclination to invest in real estate directly. However, they can still access the benefits offered by real estate through passive property investments. There are a number of investment vehicles purpose-built to allow exposure to the real estate markets without the hassle of actually buying and maintaining physical property.
Real estate investment trusts pool investor capital to undertake projects that individual investors would not be able to capitalize alone. Many are traded on the public markets, similar to traditional equities. REITs come in three forms, equity, mortgage and a hybrid of the two. These are by far the most common real estate assets for average investors. Share prices for REITs range from penny stocks all the way up to preferred shares worth substantially more.
Real Estate Funds
These funds invest in a wide variety of property types and often generate much of their returns from appreciation in addition to the regular cash flow offered by commercial properties. They are professionally managed and tend to benefit from the large-scale capital investments that are far and above most individual investor capabilities.
Real Estate Company Stocks
These are publicly traded equities of companies that work in or adjacent to the real estate markets. They provide everything from agent services, to digital sales solutions, and everything in between. Popular examples include Zillow (Z) and CBRE Group, Inc. (CBG). They rise and fall with the real estate market and broader economy, and do not have the same counter-cyclical resistance that many forms of housing possess.
There are three main benefits offered by passive real estate investments. They include:
The most limited resource we have is our time. Active real estate investing can be incredibly time-consuming- finding properties, getting financing, and managing a property portfolio is essentially a full-time job. Passive investments allow doctors to do what they do best- heal people- while professional financial managers grow their retirement portfolio.
Benefit from a Larger Capital Pool
Passive investments often take the form of REITs, real estate funds, and publicly traded real estate companies. What all three of these vehicles have in common is their ability to raise and deploy capital at a level far higher than any one investor can manage. This opens up new, profitable opportunities that are not available for investors with lower levels of capital.
One reason many high-net-worth individuals flock to real estate is the ability to deduct property depreciation from their annual tax bill. Despite popular perception, many passive real estate investments allow holders to receive these benefits without direct ownership and management of a rental property. Many of the wealthiest people in the United States hold real estate assets for the tax-depreciation advantages alone.
As a medical professional, you wouldn’t entrust your personal health to a non-expert. Why take that chance with your retirement savings? Passive investments typically have finance professionals that direct acquisitions and manage individual properties, so you don’t have to. They can leverage their education and experience in the real estate and property rental sector to generate returns above and beyond what a part-time investor could do.
No Dealing with Lenders
Direct real estate investors usually have to become intimately acquainted with commercial lenders. As financing a project may be prohibitively expensive, investors often work with commercial lenders to raise funding for acquisitions or rehab projects. No one likes jumping through lender hoops- and passive investors don’t have to as most investments are capitalized through investor contributions.
Rental properties are among the most popular alternative investments for retirement savers. They are particularly attractive to physicians due to their substantial tax advantages, which can help offset, defer, or eliminate much of your tax burden, especially if you fall into a higher tax bracket.
Direct Investing in Rental Properties
Direct investing entails sourcing, purchasing, and managing investment properties. Common rental properties include single-family homes, townhouses, and condos, as well as multi-family apartment buildings. Direct investment is considerably more time-intensive than other forms of real estate investment, and many small-scale investors suffer from reduced portfolio diversity, due to the outsized capital contribution required to source, maintain, and manage a rental property directly.
Passive Investing in Rental Properties
For retirement savers that do not have the time or patience to deal with agents, brokers, appraisers, and tenants, they have the option to make passive investments through real estate funds, REITs, crowdfunding deals, and other managed commercial real estate investments. Passive investments offer the same tax, appreciation, and cash flow benefits, with far less work on the part of the investor.
Which Option is Better?
Two factors will determine whether passive or active real estate investment fits into your retirement portfolio- whether or not you have the time and ability to find and manage profitable commercial properties. Passive real estate investing also holds some advantages over direct/active investing.
With direct real estate investing, you might work with real estate professionals, attorneys, etc., but their ability to help you may be limited. With a real estate fund, REIT, or other passive investment, you gain scale and diversification advantages that cannot be matched by a direct investment. At the end of the day, each situation is different, and any investor looking at passive or active real estate investments should weigh their desired return and risk profile before undertaking any real estate investment.
When setting out to build a commercial real estate property portfolio, remember that the process is very similar to creating a well-performing equity or stock portfolio. Investors should focus on acquiring assets that they believe have a high chance of generating their desired risk-adjusted returns. Here are some areas to focus on when setting out to build a commercial real estate portfolio:
Risk assessment for commercial properties takes three forms: property/building due diligence, market research, and a deep dive on the financials of a potential acquisition or development. Market research can be conducted via internet search, property records, real estate information aggregators like Zillow and Redfin, as well as market-tracking indices like the NCREIF Property Index or the NAREIT Index.
By far the biggest mistake made by novice real estate investors when putting together their portfolio is to not properly diversify their holdings. In real estate, diversification means acquiring assets in different geographic locations and different property types. For example, one might hold a multifamily building, a self-storage facility, and a retail shopping center in the same portfolio to hedge against risks of a recession- while the shopping center may see a loss of tenants or lowered rents, the multifamily space should expand during an economic contraction. Each asset balances out the others to allow your portfolio to weather economic storms.