The stock market has suffered many shocks in the past few months. These shocks have investors wondering if the decade-old strong market is beginning to wind down. Higher rates and other signs seem to point toward a downward shift in the market cycle, and it has many investors looking at investing elsewhere.
Currently, one of the strongest markets is commercial real estate. However, many investors fail to realize there are many ways to invest besides just buying property and that the opportunities within commercial real estate can help them gain attractive risk-adjusted returns. In fact, an investment in real estate can be a nice balance between the volatility of the equities market and the barely there returns of a bank deposit. Commercial real estate can balance the risk and return while still providing cashflow to a portfolio.
However, there are somethings you should consider before investing in commercial real estate.
First, realize commercial real estate investments come in two forms: equity and debt. Equity investments usually take forms of buying stocks in a company that specializes in commercial real estate or buying a property outright. Many mutual funds and ETFs are happy to offer equity opportunities in the commercial real estate market. However, the risk-return profile for an equity investment can vary widely. Before you make an equity allocation, contact a financial advisor to ensure you are aware of all risks.
Private debt is another way to invest in commercial real estate and is a safer and potentially more lucrative way. Private debt in commercial real estate is backed by physical property as collateral, which makes it more secure than other forms of private debt like consumer debt or student loans. This collateral minimizes the risk of default and ensures you gain something out of the loan even if a default occurs. Private debt can put stability in your portfolio and has absolute returns in the 6-12% range.
When choosing between an equity investment or debt, it’s essential to consider the market. Early in a cycle, it’s best to make an equity investment; this provides the highest return potential. However, the later you are in the cycle the better it is to invest in debt because the risk is dramatically lowered. We are in the longest upward real estate cycle in a century. This indicates we are at the top of the cycle and will soon be winding down.
The second thing you need to consider before investing in commercial real estate is that not all markets are equal, especially in the United States where prices and valuations can vary greatly from state to state and city to city. While the most mature real estate markets are going to be in large cities like New York, the best opportunities will most likely be found in suburban communities and second-tier cities. The most successful commercial real estate investors know this and have taken pains to get a real estate education in these markets. Understanding the local market and what economic or demographic trends are at play is essential to know the value of a property.
Before investing ask yourself. Is the local population growing? Aging? Are there infrastructure projects in development? Knowing what questions to ask and finding the answers can be the difference between a loss and a return.
No one can deny that commercial real estate is a growing market. If one considers opportunities carefully and strategically, they could make a huge return.