CrowdStreet’s VP of Investments Ian Formigle lists the top reasons that commercial real estate is attracting a broader investor audience to the sector
One of the main reasons that institutional and private investors alike are pursuing real estate investments right now is that they are chasing yields. Real estate returns are attractive compared to alternatives in stocks, bonds or even other commodities such as gold. One benchmark for measuring investment performance for a large pool of individual commercial real estate properties in the private market is the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index, which measures the performance of an immense pool of individual commercial real estate properties on an unleveraged basis. The NCREIF Index reported an annual return of 12.7% in 2015, which bested other key indexes such as the S&P 500, Dow 30 and Russell 2000. On a longer term view, the NCREIF Index has reported an average annual return of 8.8% over the past 15 years, which is 200 basis points above the average performance of the S&P 500 for the same period.
Real estate investments are often structured to deliver steady cash flow with dividends that are distributed to investors monthly, quarterly or annually. The two main options for investors are to make either an equity investment or a debt investment.
Equity investments on the CrowdStreet Marketplace involve buying a passive, minority ownership stake in a hard asset, such as an apartment community or office building. High occupancies and rising rents generally deliver what most owners/investors strive for – steady or rising cash flow over time.
Debt investments refer to investing in a real estate loan. Those loans are backed by an underlying asset as collateral, such as land or a building. One of the advantages of debt investments is that they are generally structured to deliver a fixed return. For example, in 2014 the CrowdStreet Marketplace offered a $6 million mezzanine (second position) loan investment on behalf of Everwest Real Estate Partners (“Everwest”). Everwest offered CrowdStreet investors a 10.5% fixed interest rate paid quarterly over a targeted five-year term. The collateral is a 687,000 SF, 91% leased, four-building business park located in the New York Metro area with AT&T as the anchor tenant. In this case, Everwest is the lender so CrowdStreet investors are benefitting from the opportunity to co-invest alongside the loan manager in a loan that was already closed and paying a current return.
Specific to equity investments, investors have the opportunity to boost their overall return by cashing in on property appreciation or a capital gain on an asset once it is sold. Property values certainly rise and fall during market cycles, which makes timing the exit strategy a critical aspect of maximizing investor value. Some investors can reap the rewards of opportunistic buys that allow them to buy, fix and flip an asset in a relatively short period, such as one to three years. Other investment strategies, more predicated on the prospect of stable cash flows, might target a hold period of five to seven years or longer.
While realizing appreciation and capital gains is a definite incentive to real estate ownership, there also is depreciation on the other end of the spectrum. Depreciation decreases the accounting value of the physical structure of a real estate asset, as most assets decline in value over time, but does not affect the market value of a property. In its most basic form, the physical improvements of a property may be depreciated over a 27.5 year period in an accounting method referred to as “straight line depreciation”. However, certain improvements (e.g. appliances and flooring) may be depreciated over a period as short as five years. Depreciation is utilized by real estate operators as a tax benefit tool, which allows an investor to utilize a passive “loss” from depreciating improvements to offset other passive income. The net result is a higher after-tax yield. As the tax benefits of depreciation are dependent upon an individual’s or entity’s taxable income, investors are strongly encouraged to consult a tax advisor.
For assets that are mortgaged with a fully amortizing loan (in most cases over a 30-year period), the property’s revenues service an outstanding debt that reduces with each month’s payment. Think of it as a monthly savings program – the rents paid by a property’s tenants reduce the asset’s leverage, which in turn, increases equity and, hence, investor returns at the point of exit (which at 75% leverage can amount to 25% of total returns) while also reducing risk. In a world of investment uncertainty, principal paydown infuses an element of month-over-month certainty of returns.
Another key advantage of real estate investing is that it is a good way to diversify portfolios that are backed by hard assets. Real estate is not the same as buying shares in a company that may be here today and gone tomorrow. Certainly, cases such as Enron and Lehman Brothers have proved that even stalwart corporations are not infallible. Real estate is an asset class that investors can literally touch and feel. Yes, some building occupants may come and go, and there may be ups and downs in building valuations over the course of its life, but the property itself is not going to disappear.
Written by: Ian Formingle
Headquartered in Portland OR, CrowdStreet is a software and services company disrupting the commercial real estate industry by enabling innovative real estate operators and developers to efficiently engage in online capital formation, communicate with investors, distribute investment documents and centralize ongoing investor relations. For more information visit CrowdStreet.com.