Friday, September 21, 2018

Is Commercial Real Estate a Good Investment? Five Reasons it’s NOT!

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Seemingly an easy answer - of course it is! However, the more difficult response - for which I will delve today - is it depends.

As we have covered, commercial real estate exists in many varieties - a suite of offices, a manufacturing plant, a distribution warehouse, a retail storefront or big box, finally a residential project of more than four units. Yes. That small apartment complex is considered commercial real estate.

Your ownership is one of - “my business lives there” or “I simply collect the rent from tenants who occupy the spaces”. Today, we will treat both ownership classes the same - after all both are investors - albeit with different objectives.

An investment in commerical real estate garners the benefits of cash flow, long term appreciation, depreciation, treatment as a long term capital gain and the ability to postpone taxes upon sale through the use of a 1031 tax-deferred exchange. But beware - you must also deal with vacancy, flaky tenants, fixing the roof, collecting the rent and paying the bills, obsolescence, roll-over costs, entity tax returns, and broker fees.

So, to the tough query of commercial real estate as an investment - let’s examine several scenarios under which commercial real estate falls under the category of “it depends”.

A liquidity event. This is a fancy way of saying “you must sell”. Reasons for a sale could consume an entire column. But, if the timing of the disposition runs counter to the market - IE a forced sale in 2009 - lost is all of your gain. During that period, we saw values drop 30-50% in a matter of weeks. Be happy you weren’t a seller!

A sale of the business that occupies the building. Owned is your company’s address. Your business is your tenant. You pay yourself rent each month. What could be better? Frankly, nothing. This is a wonderful arrangement many small businesses enjoy in California. However, if you sell the business - you no longer own the “tenant”. Is there a reason your occupant MUST stay in your building? Or will they flee to cheaper environs once the lease expires?

A mis-match of risk. Single payers - such as a Dollar General store or a Caliber Collision Center offer the owner one rent check each month. There-in lies the benefit and the risk. So long as the tenant’s business is vibrant - money flows in to your bank account. A blip - and you’re installing a “For Rent” sign.

A dispute. Divorce, partnership squabbles, or a change in motivation all can occur during the life of an ownership. Unless specially structured - ownership shares are not easily divided - in other words - you cannot simply take your toys and go home.

Aging owners. Wow! Once again - a column worthy topic on its own. Here is a preface. Those greying temples and aching back - stem - not from age - but from the pains of commercial real estate ownership. Told were you in your thirties - “invest in real estate”, young lady. You have. You’ve achieved a nice portfolio over the years with timely purchases, well-timed trades up, and careful management of the occupancy, income and expenses. But you are tired! Akin to captaining a ketch - tiny tweaks and tightening take time and talent. In order to capture the winds of income - your sails must be trimmed and you must stand watch over the ocean swells of expenses - lest your vessel should capsize. Whew! How about we find a nice cozy port - drop anchor - and relax. But, your ports are limited - as we will discuss next week.

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