Key Takeaways

  • Traditional financial advice encourages investors to allocate their funds to a diversified portfolio of stocks and bonds.  We believe there is a strong argument to be made for the inclusion of real estate.
  • Commercial real estate offers many of the same benefits as residential – income, appreciation, and tax deductions, but at greater scale.  However, it is expensive and requires significant time and operational expertise to manage.  For this reason, a passive commercial real estate investment may be the best option for many individuals.
  • Passive commercial real estate investment options can be divided into two buckets, REITs and Private Equity.
  • Private Equity Commercial Real Estate Investments are similar to REITs, but are only available to accredited investors who meet certain income and net worth requirements.

In most cases, the prevailing financial advice on saving for retirement dictates that individual investors open a tax-advantaged retirement account and use the funds in it to invest in a broadly diversified mix of stocks, mutual funds, and bonds. While this is a time tested strategy that has proven to be successful for many, it isn’t the only strategy. There is a strong case to be made that real estate deserves some level of allocation in an investment portfolio.

Why Real Estate is a Good Investment

There are four primary reasons why individuals should consider a real estate investment:

  • Diversification: Owning real estate adds an element of diversification to the traditional stock/bond portfolio. This is because real estate prices tend to have a low level of correlation with those of stocks and bonds, meaning that when stock and bond prices go down, real estate prices tend to remain somewhat stable. This can ultimately help to offset losses in other areas of the portfolio.
  • Inflation Hedge: Real estate is a tangible asset, the value of which tends to rise over time. As such, there is no erosion in its value due to inflation.
  • Depreciation: IRS rules allow real estate owners to take a tax deduction for a portion of the property’s value each year to account for the deterioration in its physical condition. This deduction reduces the owner’s tax liability.
  • Income & Appreciation: Rental properties produce rental income that can supplement the wages an owner earns from his or her primary source of employment. Or, if an individual chooses to pursue real estate investing on a full time basis, the cash flow can be used as their primary source of income. In addition, if the investment property is located in a strong real estate market, investors may benefit from price appreciation, which can lead to a nice profit should they decide to sell the property.

For those convinced that real estate is indeed a good investment, there are a variety of options to choose from.

Residential Real Estate Investment vs. Commercial Real Estate Investment

For many, the easiest way to invest in real estate is with the purchase of a residential investment property. The premise behind this investment is simple: a down payment is made to purchase a property, which is then rented to an individual or family. The income earned from the rental is used to pay the property’s operational expenses like taxes, insurance, and mortgage payments, and any remaining funds are distributed to the owner(s) as a return on their investment. Residential properties can be rented on a short-term basis as vacation homes or an Airbnb, or on a long-term basis of 12 months or more.

Residential real estate investors benefit from low barriers to entry (e.g. affordable purchase price), income, price appreciation, and wide availability of debt, at low interest rates, from a number of different lenders to finance the transaction. However, residential property investment is not scalable and a significant amount of work is required to screen potential renters to ensure they have a good credit score, in addition to the time and effort needed for maintenance, upkeep, and general property management. For investors seeking scale and passive income, they may find that commercial real estate is their best investment option.

Commercial real estate properties are those that are purchased and leased to other businesses with the intent to earn a return through income, appreciation, or both. The investment thesis is the same as a residential property, but the scale and complexity is magnified. There are four types of commercial properties: retail, multifamily, office, and industrial—and each comes with its own set of risks and operational quirks.

Commercial investors benefit from income, capital gains, tax advantages, and portfolio diversification. But commercial properties are expensive and typically available only to individual investors with a high net worth when purchased directly. These investments are also operationally complex and tend to demand a lot of time from their owners. In fact, many commercial properties require a full time property manager in order to maintain property value.   

We believe that a commercial real estate investment is the best option for individuals seeking passive income through exposure to real estate assets. Generally, passive commercial real estate investment options fall into one of two buckets: Real Estate Investment Trusts (REITs) or Private Equity.

REITs vs. Private Equity

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. Because REITs are formed as corporate entities, investors are able to purchase shares in them, providing access to the rental income and profits produced by the underlying assets. REITs can be publicly traded, which allows investors to buy and sell shares like stocks or mutual funds, providing a high degree of liquidity. Or, they can be private, which provides less liquidity, higher management fees, and a longer term commitment.

REITs tend to be a good option for investors who don’t have the time, expertise, or capital to make a direct commercial real estate purchase. They provide the passive income of real estate ownership with neither the time commitment nor hassle of managing it on a day-to-day basis. Generally, there are 4 types of REITs that investors can choose from:

  1. Equity REITs: Equity REITs are publicly traded companies (their shares can be bought and sold in the stock market) that own or operate income-producing real estate for the purpose of distributing dividend income to their shareholders. The majority of REITs fall into this category and are considered attractive because of their liquidity and high dividend yields. Equity REITs can specialize in specific property types like apartment complexes, office buildings or single-family homes. 
  2. Mortgage REITs (mREITs): Mortgage REITs (mREITs) provide financing for income-producing real estate by originating mortgages or purchasing mortgage-backed securities. They earn income from interest on the loans and/or dividends from security investments.  
  3. Public Non-Listed REITs: Public, non-listed REITs (PNLRs) are registered with the SEC but do not trade on national stock exchanges. However, they follow the same philosophy of investing in income-producing properties for the purpose of distributing dividends to their shareholders.
  4. Private REITs: Private REITs are exempt from SEC registration requirements and their shares do not trade on national stock exchanges. To invest in a private REIT, investors must meet income and/or net worth hurdles or demonstrate that they are sophisticated enough to understand the risks of investing in non-publicly traded securities.

Private Equity

Private Equity Real Estate firms and REITs have a similar mandate—to pool investor money and deploy it into real estate assets. However, the securities offered by Private Equity Real Estate firms are not publicly traded and they are only available to accredited investors. 

Because they aren’t bound by the same regulations as publicly-traded REITs, private equity real estate companies have wide latitude to invest in a variety of real estate asset classes, which may or may not include income-producing rental properties. In addition, the legal structure may differ significantly from a REIT and they are not required to pay out a high percentage of their income in dividends. Instead, the majority of private equity returns are derived from profitable investment exits in the form of capital gains and carried interest.

When working with a Private Equity firm (like ours), investors are able to leverage the institutional expertise and experience of the firm. In addition, they can expect that the transaction will be structured in a tax-efficient manner and that the financial incentives of the firm will be aligned with those of the investor.

Private equity firms offer a number of different investment options, products, and strategies.  Individuals should ensure that the chosen investment is a good fit for their own needs and objectives.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in. 

If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.

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