aving and investing are two important elements of building future financial stability. For many, finding a balance between risk and return is the most difficult part of an investment decision.
Both commercial real estate (CRE) investing and certificates of deposit (CDs) offer some risk reduction: they are each insulated in their own way from the rise and fall of the stock market. The similarities, however, end there.
While highly risk-averse investors may lean towards CDs, it’s important to fully understand what opportunities are missed by turning away from CRE. Recent changes in investment law have opened the door for many new investors to enter the commercial real estate space, and within that space, opportunity abounds. Here are some benefits CRE investing brings where CDs fall short:
The most obvious, and immediate, way commercial real estate investments differ from CDs is in the cash flow they provide. With a CD, an investor hands money over to a bank and often agrees to leave it untouched until the CD has matured. This means locking up cash for as long as six years, with no access to the interest gains until that time is up.
For investors seeking more cash flow, CRE investment is the way to go. CRE properties typically have tenants paying monthly rent. Whether investing in a property with a group or outright purchasing a commercial building, this monthly income provides cashflow CDs can’t compete with. What’s more, rental income tends to far outpace the returns on interest which bank-issued CDs offer.
Tax breaks for real estate property are no secret. In fact, they are a critical part of assessing a commercial property’s profitability. Fortunately, there are plenty of tax advantages when it comes to investing in commercial real estate.
Interest paid on CRE property mortgage, for example, is tax deductible. For buildings more than 39 years old, so is the its depreciation. Even expenses for renovations, maintenance, and upgrades can be deducted if they improve the value of the building. For those investing in CRE as a retirement plan, the comparably lower capital gains tax rate is attractive, and property left to beneficiaries is only taxed on increased value from the time of an investor’s death.
All interest earned from CDs, by comparison, is taxable. This is true even for CDs where interest is added back to the principle, meaning a CD holder pays taxes on income they haven’t touched yet. Also, these taxes cannot be deferred for more than one year, and there are typically early withdrawal penalties.
Hedge Against Inflation
Inflation is inevitable. It wasn’t very long ago that a can of soda only cost 25 cents, and it won’t be long before one costs $3. A dollar put into a savings twenty years ago won’t buy nearly as much today. That’s why investors keep inflation in mind when setting money aside; gains must outpace inflation so that the money is still worth something in the future.
On average, CDs provide an interest return of less than 2.5%. The Federal Reserve’s core inflation rate is 2%. After taking into account the taxable nature of CD interest gains, it’s easy to see why they are seen essentially as savings accounts, unable to keep up with inflation.
Commercial real estate, however, rides along with the inflation wave. As inflation goes up, the values of commercial properties follow suit. A $500,000 building today appreciates in value concurrently with the market, becoming worth $900,000 as dictated by demand. Especially in urban areas with limited land, appreciation happens without any additional effort on the part of an investor.
Appreciation isn’t the only way to hedge against inflation and make the most of a CRE investment, though. The value of a property can also be increased through remodeling, increasing occupancy, or other adjustments. Improvements can range from cosmetic to structural—and even include installing new appliances or purchasing adjacent land to expand. All these expenses, of course, are also tax deductible. These hard asset benefits are not possible with a CD.
Hard Asset Leveraging
When looking to expand a portfolio and increase investments, another benefit CRE offers is the ability to leverage one property to buy another. Even without possessing the funding for a large property, investing or buying based on the value of a currently held one is very common in CRE.
CDs, on the other hand, cannot be leveraged against in the same way. While some CD holders can borrow against a CD for the principle amount, it isn’t ideal, and typically only covers short-term needs rather than contributing to long-term investment strategies. Money in CDs, for the most part, is tied up and lacks the benefit of liquidity, unlike commercial real estate.
Getting Started with Commercial Real Estate Investment
Thanks to the JOBS Act, CRE investing is more accessible than ever before. As a result, PRC is creating a short-term, open-ended debt fund for accredited investors. The investment crowdfunds CRE transactions, and liquidity is guaranteed after one year. This provides a far better investment opportunity than traditional CDs. To learn more, reach out to us at PRC today.