Real estate as an investment can take many forms. For example, you can buy an apartment building or a retail store and collect the rent, or you can own the building in which you work and rent it to yourself for tax purposes.
“You can choose to either invest in a company’s debt through stocks or in the actual real estate that houses the company,” says Terry Coyne, SIOR, CCIM, an executive vice president with Grubb & Ellis.
He says the investment market for real estate is growing across the country and now is a great time to get involved because interest rates on loans are so low.
“The best way to affect the return on your investment is to get the lowest interest rate you possibly can get on your loan. The higher the interest rate, the higher the return needs to be for you to break even on your investment, but interest rates are really low right now,” Coyne says.
Smart Business spoke with Coyne about how to use real estate as an investment vehicle.
What should someone know before investing in real estate?
It is important to understand that real estate is illiquid. If you expect to get out of an investment in less than three to five years, real estate is not for you. You have to gauge your liquidity threshold.
The investment’s illiquid position also means that it can be tougher to price than other assets — your investment could be worth more or less the moment after you buy it.
If you have a need for a short-term investment, real estate is not an investment for you. However, if you tend to overreact to market fluctuations, real estate investments can keep you from selling early because it is more difficult to sell your investment.
What types of real estate investments are available?
There are several, and you need to examine which asset class best suits your position — office, industrial, retail, multifamily housing, land, mini storage or medical. Each one has its pros and cons.
Office property investments take a lot of capital because you will likely need to suit the office space to accommodate each tenant. Industrial properties don’t take as much capital and are often a simpler deal.
Medical property investments are all the rage now because it is almost quasi-retail and location becomes important. However, it is expensive to build out and it is difficult to move.
Investing in land can be the more challenging of the real estate investments because it is incredibly illiquid. If you choose to invest in land, you had better have a long time horizon and be prepared for the laws to change on you. You have to be patient and smart if you are buying land.
Mini-storage is akin to investing in a business — part real estate investment and part business investment. Similarly, owning an apartment building is a business investment. Before you make an investment in this type of property, you should know what you are getting into.
Buying the building that houses your business is more of a tax play. When you are buying and leasing to yourself, the rent is taxed at a lower rate than income. However, as the landlord and tenant, you can’t call someone to fix a problem. But if you take care of the property and take advantage of the property tax claims, you could offset your lease payments.
You could also invest in real estate through the stock market by investing in a real estate investment trust (REIT). This gives you some exposure to real estate investing but with the liquidity you find with stock. It is a good way to learn about the market before making a more illiquid investment and can serve as a halfway step to investing in a physical building.
What else should you consider before choosing a property?
After you have determined the liquidity risk and asset class, select the area in which you’d like to make the investment and set your budget. Once you have gone through these initial steps, find someone who is an expert in the asset class, location and price point you’re working with to help you find the right investment. Choose a broker from a national firm, as that person will be able to help you compare investments from across the country.
What are the risks associated with real estate investment?
Just as you have determined your liquidity threshold, you also have to decide your risk threshold. You are buying a physical asset, and if you’re paying two or three times what it costs to replace it, you had better make sure that the credit of the tenant is worth it.
A very good, credit safe investment tends to have a high cost per square foot that is much higher than the replacement cost. But if you have a low-credit tenant that goes bankrupt, you’ll be stuck with a building that needs significant capital to improve, and you may not be able to find another tenant to take the space. So what you’re really investing in is the credit of the company.
As an investor, the more responsibility that you put on the tenant, the less you are involved. The best deal for a landlord is triple net, in which case the tenant pays the real estate taxes, building insurance and maintenance. However, the triple net leases tend to be more expensive for the tenant. The opposite of this is a gross lease, in which case the landlord pays for all property charges and maintenance.
Terry Coyne, SIOR, CCIM, is an executive vice president with Grubb & Ellis. Reach him at (216) 453-3001 or [email protected]
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