Article 1 of 5: Real Estate As An Investment Option
This is the first in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
For centuries, the two investments performing best over the long-term have been stocks and real estate. Today, most people start building their wealth in the stock markets. For established investors, here’s why you want to consider adding real estate exposure to enhance your portfolio.
Real estate has a different return composition.
Over the long term, established company stocks (i.e., the S&P 500 Index) have average annual returns in the 10% – 11% range. This comes from an 8% – 9% appreciation and a 1½% to 2% dividend yield. Stabilized commercial real estate averages about 4% appreciation, with a 5% – 6% yield from net operating income.
Both benefit from long-term capital gain tax rates. Real estate offers additional tax benefits from pass-through depreciation, which reduce ordinary income and may be subject to “recharacterization”, usually at 25%.
Real estate has a lower risk profile than stocks.
Stock prices can fluctuate dramatically with quarterly earnings surprises, broad stock market gyrations and investor emotions. Real estate prices are driven by demand, net operating income (NOI), and interest rates, which all move more slowly. Demand can be driven by sector (apartments or warehouses, e.g.) or by the growth or decline of a specific market. Rising borrowing costs can restrict net income, which is often offset by inflation boosting price appreciation.
Real estate behaves differently than stocks during economic cycles.
Stock prices are driven by earnings expectations and rise or fall in anticipation of changes in corporate earnings and broader economic forces. Building values tend to be much more stable through cycles, as values are determined by consistent income, not ever-increasing profits. This does put importance on what real estate you buy and where it is.
Geography and sector diversity are important considerations.
Population shifts, regional economies, state-specific tax, and business climates all impact real estate. Real estate has many different sectors. For example, offices, hotels, retail, and senior housing all react differently to economic cycles and demographics.
If you’re interested in learning more, reach out to us about your situation.
Better understand geographic and sector diversity in our second installment, “All Real Estate Investments are Different”