While new investors may only see barriers to entering the commercial real estate realm, passive investing provides some incredible advantages.

From the passive income to the tax benefits to the experience of working with seasoned professionals, passive commercial real estate investing offers incredible opportunities that more than justify any barriers to entry.

In this article, we’ll outline seven specific advantages to this investment strategy.

Advantage 1: Risk Diversification

Regardless of whether you’re investing in stocks, bonds, precious metals, or commercial real estate, savvy investors understand the importance of risk diversification in a successful portfolio.

By its very nature, commercial real estate provides investors tremendous potential for diversification.

While many outsiders view commercial real estate as a monolithic entity, in reality, the field is made up of a variety of different asset classes. For example, a passive stake in a student housing complex may provide a counter-cyclical hedge, as university enrollment generally increases during economic downturns.

On the other hand, holding a stake in a hospitality project typically offers investors performance that mirrors the overall economy, as people tend to travel more frequently during strong economic periods.

And, asset class diversification isn’t the only means to mitigate commercial real estate risk, as investors can also diversify their portfolios with the following strategies:

● Multiple-tenant commercial properties

● Investing in different markets

● Investing in multiple properties

Local commercial real estate professionals can help you find great investment opportunities in your market - need help finding reliable ones in your area? Drop us a note!

Advantage 2: Leverage

Simply put, leverage entails the use of debt (borrowed money) to finance a project, in this case, commercial real estate.

Employing leverage with commercial real estate investing has two major benefits:

● Increase buying power: Investors with $100,000 in capital would be limited to a $100,000 deal without access to debt financing. However, with a $100,000 down payment, investors could reasonably finance a $500,000 project with 80% LTV.

● Increase return on investment: In addition to the increased buying power, employing leverage increases an investor’s return on equity. In other words, despite the additional interest costs, putting less of your own money into a deal - and receiving the same rents as if you 100% self-financed - leads to a higher percentage return on owner equity.

Bottom line, leverage lets you A) buy more, and B) realize a higher return for every dollar invested.

Understanding commercial real estate lending can appear complicated for new investors, so please drop us a note for an overview of the pros, cons, and general procedures of commercial lending.

Advantage 3: NOI-Based Appreciation

As commercial real estate brokers will explain, appraisers don’t treat residential and commercial real estate the same way. Due to the unique nature of commercial projects and their use as income-producing assets, they are valued with an NOI-based approach, not via sales comps.

A commercial property’s capitalization, or cap, rate is the return an investor would receive on an all cash deal. Mathematically, this means that cap rate equals a property’s NOI divided by its value (e.g. a $50,000 NOI on a $500,000 property would equal a cap rate of 10%).

Looking at this as an equation, investors can increase the value of their property in one of two ways: 1) decrease the cap rate; or 2) increase the NOI.

While commercial cap rates are typically driven by market forces outside of an individual investor’s control, investors can control the appreciation of their commercial properties by increasing NOI, either through increased rents or decreased operating expenses.

This reality means that, more than any other passive investment, commercial real estate investors have the direct ability to influence the valuation of their investments.

Advantage 4: Teaming with Experienced Professionals

Understanding how to properly analyze, or underwrite, a commercial real estate project often serves as the primary obstacle to new investors taking an active role in a commercial deal.

As such, teaming with experienced real estate professionals has three major benefits:

● Gain access to a commercial real estate deal without the requisite expertise

● Gain experience and knowledge by working with expert investors

● Scale your passive income with new commercial projects

While more and more deals are structured as LLCs rather than limited partnerships (LPs), the role of a passive investor in either legal structure is essentially the same. You provide the money and receive returns, while the active member (managing member in an LLC or general partner in an LP) runs the project’s day-to-day operations.

However, as with any investment, before providing anyone your money, make sure it’s someone you know and trust. Or, if referred to you, due diligence requires at least talking to previous investors and creditors about what working with someone is like.

Advantage 5: Tangible Asset

Investing in commercial real estate, you’re investing in projects you can feel and touch. Sure, shareholders of large companies can technically go and see a company’s operations, but most minority shareholders aren’t spending much time at Apple or Microsoft headquarters.

And, this tangible nature has two key benefits to passive commercial real estate investors:

● Income and asset value: In addition to the income generated by a commercial investment, investors also have access to the property’s underlying value. Worst-case scenario, if a tenant defaults on rent payments, commercial real estate investors still have this underlying value as downside protection.

● Stability: Unlike the daily fluctuations of the stock market, commercial real estate serves as a relatively stable investment. While values certainly fluctuate, the long-term tenants inherent to commercial properties make these investments stable and predictably performing assets.

Advantage 6: Tax Benefits

For passive investors, commercial real estate offers tremendous tax advantages. Specifically, investors can deduct the following items, oftentimes creating a positive cash flow situation while still recognizing a taxable loss:

● Loan interest: For debt-financed properties, investors can deduct the interest portion of a property’s debt. And, unlike the personal mortgage interest deduction allowed by the IRS, commercial investors do not face a loan-size ceiling for deductible interest.

● Depreciation: As a cashless deduction, property depreciation allows investors to significantly decrease their taxable income - without an associated reduction in cash flow. And, while investors do ultimately need to pay the IRS via depreciation recapture, techniques like Section 1031 exchanges allow long-term tax deferrals.

● Operating expenses: Additionally, all the standard operating expenses necessary for a commercial property constitute deductible expenses. Property management, utilities, maintenance, etc. - all of this can be deducted to reach taxable income.

Advantage 7: Build Passive Income Streams

At the end of the day, becoming a passive investor is all about generating passive income. Put simply, passive income is the money your investments generate based on the managerial efforts of others.

You provide the funds and receive the returns, while other people provide the effort.

And, this passive nature has two tremendous benefits:

● It buys you time: Most people have countless things they’d rather be doing than going to a job and working from 9 to 5 every day. But, if you rely on active income, that’s the reality - stop work, stop making money. With passive income, your time is your own - regardless what you do with your day, money keeps coming.

● It’s taxed at a lower rate: From a tax perspective, passive income actually means something different to the IRS. Unlike the top federal tax rate of 37% for active income (e.g. salary), passive income is taxed at a maximum rate of 20% - potentially leading to massive tax savings.

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We recognize that, even after outlining the above information, investing in commercial real estate can seem daunting.

That’s why we’re here to help. The Pocket Broker team lives and breathes commercial real estate, so drop us a note to see how we can help you achieve your unique objectives!

7 Awesome Advantages to Passive Commercial Real Estate Investing