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Commercial Real Estate: as an investment, not as it relates to the stock market



March 24, 2010 – Comments (26)

Hi all, I know this is a website/game/blog devoted to stocks and stock picking and stock markets and the like...  but...  There are other investments available, and one of the most common (at least in my area) is rental property.  Commercial Real Estate.  CRE.  I have met many more people here that invest in some kind of rental property than people who invest in equities, bonds, and other niceties that the capital markets and yahoo finance give us access too.  Now, my area of the country may be an exception, as its rather conservative and I maintain (and may test this later, and have tested it in the past) that if you went to the local pub and found a pretty girl around my age and mentioned, in a sentence, the S&P 500 you'd be overwhelmingly unlikely (near zero, running bet with some chums) to ever find one who knew what its value was, if even what it was at all.  The Dow is of course more common.  So far in said running bet:  zero, ever, have known what the Russel 2000 was.  Not one time.  A tiny handful had heard of the S&P, none new its closing level or even an approximation of its closing level. 

This is how I humor myself on days when I have a bad attitude.  On days when I have a good attitude I (I swear to goodness) go out and just tell people I work at some store in the mall.  Its just a whole lot easier than explaining what I do for a living to people.  

But enough about my quasi-complaints and ongoing amazement at how oblivious to investing in stocks the world directly around me is...  (this and the nearest city with 10k+ people have like the lowest unemployment in the country.  All that obliviousness and the conservative demeanor it belies are not without their advantages).  One last comment:  number of people who, after asking what I do for a living, have told me that stocks are gambling or to "be careful, you can lose it all just like that" in stocks outnumber the number of people who know what a price to earnings ratio is by 17 to 2.  

Anyway, to contrast the massive ambiguity in the equity markets of my locale, there are tremendous numbers of people with their fingers in rental property.  A longtime friend (former college age girl-chasing drinking buddy, now in management at a local car dealership) owns a couple of four-plexes, another friend of mine owns a 3-plex, another friend a 10 plex, (and these are not necessarily, or even at all, rich people).  Asking prices for rental properties in the area are typically north of what the properties can cash flow if you mortgaged them with 20% down.  

I myself, a while back, bought some shares in an LLC that was formed to own a piece of CRE.  As of today this represents about 2% of my overall investment portfolio.  I have since given a great deal of consideration to CRE and its potential as an investment, and I have come up with a fairly long list of thoughts on the matter.  I see a laundry list of both pro's and con's.  


1.  Think of it as dividends without taxes.  Say you bought a commercial real estate property, like some rental office space, and you made an 8% cash-on-cash return.  The property pays a mortgage and delivers rent revenue.  It makes the payments and after your 10 or 20 or whatever percent down delivers an 8% return.  You bought, say, a $1mil building.  You put, say, $200k down.  You make, say, 8% cash-on-cash, so about $16k return.   You can depreciate the building over 27.5 years.  So about $36-37k/year of tax write-off.  So you make not 8% but actually more because you can show a loss while still making a profit.  This is huge.  The dividends from, say, T, or VZ, or LLY, or MO cost you about 20%/year in taxes.  The dividends from ARCC or other BDCs or most REITs may cost you closer to 40%/year in taxes.  0% taxes on the "dividends" from a properly rented and performing piece of CRE.

2.  Real estate is the only asset that isn't stocks that has appreciated more than inflation over the course of recorded history in the US.  Its not nearly as good as stocks, but at least its something.  Commodities haven't (just periodic fits of supreme outperformance followed by decades of poor performance), bonds haven't, etc.  Real estate has, so provided you didn't buy into a bubble thats a plus.

3.  CRE carries with it a certain visibility and sort of status/notoriety.  "I own the Ramada" means something to people, "I own 80,000 shares of Ashland Chemical" means nothing to anybody.  

4.  CRE has reasonably predicatble and widely available leverage.  You buy stocks on leverage you take on far more risks than buying real estate on elverage.  Real estate, quite literally, is basically always bought with leverage.  And massive infrastructure (banks) exist in our society to provide leverage (mortgages) for real estate.  Leverage with stocks is both probably riskier and less available and generally available on less favorable terms.  Literally anybody can lever 3 or 4 or 5 to 1 on real estate.  This leverage brings with it the potential for greater returns.  Your total return is the sum of (cash on cash return + appreciation return + debt paydown return).  You buy said piece of rental property for $1 mil, putting $200k down, with a 20 year mortgage on the other $800k, and the property pays for itself...  you are banking 8% (cash on cash) + $40k (average over the life of the mortgage) or 20% debt-reduction return + whatever the appreciation of the property is.  This creates the potential for honestly good returns.  Buffetesque returns.  Better than teh long term average of the stock market returns.

5.  CRE, in your mind, is less volatile than equities.  Imagine I began investing around the turn of 2008/2009 with stocks.  (true).  Imagine I bought in to the point where I was bascailly all in US equities (true).  Imagine I started with 10 bucks (not true, but for this discussion its fine).  I was down to 7 bucks at the march bottoms.  Up to 21 bucks at the May or June 2009 highs, down to 16 bucks at the July 2009 lows, I hit $30 bucks in September 2009 and today stand at around $38 bucks, up from $31 bucks at the February 2010 lows.  The volatility is insane.  And that volatility is a source of some stress.  That piece of CRE you own, in your own mind, is not as volatile.  Its always worth $1 mil or a little more.  

6.  You can probably extract cash from it at some point if need be.  Imagine that you bought said piece of CRE and in 10 years you'd paid down some of the loan, so you now had $500k of equity.  And the stock market crashed october of 2008 style...  you could probably take out an equity loan on the property to invest in distressed equities,... that access to cash is a huge plus.  its not certain, but it is potentially a huge plus.  


These upsides are contrasted with some downsides, some of which I have not before seen discussed in print:

1.  Its an illiquid asset.  Only in boom/bubble times is CRE actually liquid.  In normal times selling it may take months, or years, if it can be done at all.

2.  The recent (30 year) history of CRE prices is not likely to repeat itself over the next 30 years.  Interest rates and bonds have been in a 30 year bull market.  Interest rates have reached all time lows, record lows, and are likely to, at some point in the near future, begin trending higher.  This can have some unexpected consequences for the value of CRE.  For example, take our case above where one buys a $1 mil CRE property with $200k down, and expect 8% cash on cash return...  Imagine interest rates were 50% higher than today and you would expect to pay 8% on the mortgage instead of just over 5%.  In that case, ... bank CDs would be paying 5% and treasuries would be paying 5-6% and two things would happen.  A)  your 8% cash on cash return would now be a tiny loss.  the mortgage payments would go up enough that instead of taking in $16k/year, you'd be putting in $1k/year.  B)  potential buyers would not be likely to accept an 8% cash on cash return.  Today thats more than 2x the yield on the 10 year treasury.  It would be only 2% more than the yield on the 10 year in this case, and buyers may require a 10% cash on cash return to make the "risks" of CRE worthwhile.  Basically, folks, every investment is expected to yield more than the 10 year besides bank CDs.  I doubt buyers would line up for an 8% cash on cash return for rental property if they could get 6% from treasury notes that have, practiacally, no risk.  So say that a potential buyer expected a 10% return, cash on cash.  With 8% instead of 5.2% interest rates.  And assuming the prospective buyers were epxected to put 20% down, just like you...  The properties sale value would be literally 25% below todays.

The massive, monstrous bull market in real estate over the last 30 years (which has seen 2 bubbles and busts) has been hugely fueled by falling interest rates.  A rising rate environment will not be bullish for real estate investments, period.  Be it houses or investment properties, rising rates are bearish for real estate.  Higher rates, plain and simple, mean that real estate prices will fall, all else equal.  That isn't a prediction for falling prices, its a note that "ceterus paribus" rising rates are not conducive to higher real estate prices.

Nobody talks about this when they talk about CRE ...  but we are almost certainly in for a period of flat to rising interest rates.  And ... a great deal of teh bullish aspects of real estate as an investment over the last 25-30 years have been falling rates.  Plain and simple.  Rising rates are bearish for real estate.  

3.  its an illquid asset.  Imagine you are long 100,000 shares of BAC, 25% through shares and 75% through long term options.  It takes about a minute, maybe 10, to go to cash.  Thats a fair amount of options (750 contracts) and EVEN THEN, you can get to cash in about an hour, probably, without flattening the market.   You may face years, or months in a good case, before you can exit a CRE investment.  I cannot possibly explain how important that is.   

4.  The market isn't actually a market and it isn't actually non-volatile.  My mental-comfort of point 2 is actually a fallacy.  CRE markets have/will fall by as much as equities over the last -2 to +1 years.  And what your building is "worth" is actually only what someone would actulaly buy it for.  You may wind up stuck with it for a very, very long time.  

5.  Real estate, unlike equities (for now) comes with considerable carrying costs.  Property taxes (anywwhere from a couple to many percent of the value per year) and maintenance (wildly variable, potentially significant).  So far our wildly socialist leaders have not tried to institute a "holding tax" on equities.  Some day they will, trust me, as a way to further punish hard working successful people in their neverending effort to attain teh votes of lazy welfare cases (which outnumber said hard working successful people many times over, therefore are more important to our democratically elected leaders).  

6.  Real estate, unlike equities, take work to hold.  You or somebody will have to chase down late rent and evict delinquent tennats and so forth.

7.  If you can't rent it its worthless.  No guarantee your property will sit at 100% occupancy at the rents you desire forever.  

8.  It may be more work than you'd ever believe.  Buying T or VZ or MO is not alot of work.  It takes 30 seconds and selling takes 30 seconds and in between there isn't alot to worry about.  The market may crash, yes, but...  you can always sell.  The CRE market may also crash and you may console yourself mentally by saying "my building is worth a million bucks", but it isn't unless someone will pay you for it.  And MO, T, VZ are probably less likely to lower their dividends than any given piece of CRE is to give you trouble over projected rent income...  and competition for the big boring dividend stocks isn't really higher than for CRE rental.  And storms can't kill your MO, they can ruin your rental property.  And you never have to go to T headquarters to yell about getting your dividend, it just comes, but you may well have to go yell at somebody to pay their rent.  Taht may ultimately be more trouble to you than you think ahead of time.  


And that ends my summary.  My main argument against CRE as an investment is #2, and #1/#3.  Rising interest rates may spell trouble for CRE valuations for decades to come, and its long history of outpacing inflation may take a (temporary) detour.  

And the illiquidity is considerably concerning.  

If any of you are considering CRE as a potential investment, maybe these thougts will help.  And don't let #2 of the "pros" (the mentally comforting percieved low volatility) outweigh the downsides.  It may be the best investment in any given case, but it is far, far, far from without considerable downsides. 

And in a rising interest rate environment I just don't know what to think of it.  

26 Comments – Post Your Own

#1) On March 24, 2010 at 10:49 PM, checklist34 (98.89) wrote:

another "pro" of CRE is the tendency of rents to go up over time, thereby matching the tendency of dividends to rise with inflation, etc.

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#2) On March 24, 2010 at 10:53 PM, checklist34 (98.89) wrote:

i maintain that the one real, true, massive, broad pricing discrepancy in the markets is the ratio of treasury yields to dividend yields from emminently boring big old school blue chip stocks. 

a year ago mark to m arket accounting was the bet.  today this discrepancy is the basic remaining big bet, imo.  

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#3) On March 24, 2010 at 11:15 PM, Momentum21 (98.05) wrote:

Checklist - keep in mind that real estate is a business operation that allows for a number of strategic is not just about buying and selling. you can add-value to your investment in a variety of ways. there are lots of folks out there that really know what they are doing and can operate income producing property with lower risk and higher reward than your buddies down the street. you also have to consider leverage that can multiply the value of your investment over time...and also scale that allows you to lower your costs to an extent as you grow your business.

Real estate also has more favorable tax considerations then trading in most cases. 

Like investing or trading there are mistakes that can crush you in an instant. dealing with tenants is not easy but those who know what they are doing handle it...those that don't get consumed by it...

maybe we are saying the same thing...investing in stocks or CRE requires patience and commitment but if I had to choose between the 2 to actually earn my living the future is brighter in CRE, although the barrier to entry might be higher. 

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#4) On March 24, 2010 at 11:17 PM, truthisntstupid (87.04) wrote:

Good post, checklist

But you did just summarize, along with all the good points, all the reasons I threw a huge collection of books by Albert Lowry, William Nickerson, Robert Allen, Russ Whitney, Wade Cook, i.e., all my books on real estate investing away.  (Just in case you're curious, though, I never fell for the late-night infomercials and ordered anything off the TV.  All my books were from Barnes & Noble, Waldenbooks, etc) 

Collecting rent from belligerent drunks (that's my luck)  just didn't sound like my idea of fun.

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#5) On March 24, 2010 at 11:38 PM, starbucks4ever (67.24) wrote:

Hi checklist34,

Do you think CRE prices have more or less stabilized now, or should they drop another 15-20%?  I am inclined to believe the former, but the doom-and-gloom people have a good point when they talk about vacancy rates. If long-term leases get renegotiated now, we will see falling rates that have to be compensated by the multiple expansion, or else prices still have some more downside left.

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#6) On March 24, 2010 at 11:39 PM, checklist34 (98.89) wrote:

truth:  in 2007 my longtime biz partner, and best friend, and I (also the only person I have ever given, or who has ever given me, a black eye) were approached a few times about selling our biz, which had huge growth in a massively non-growth industry (hit hard by the recession, very hard) about selling our briiz's. 

we began consdiering selling by looking at the ROI potential of retnal properties.  We concluded that we couldn't rent apartments because of problems like that.  Belligerent drunks or... if someone cooks meth in their apartment you have to basically rebuild the entire floor per state laws.  Didn't sound like fun.  


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#7) On March 24, 2010 at 11:42 PM, checklist34 (98.89) wrote:

Zloj, I tend to disbleieve doom and gloomer worst-case-scenario folks at this point in time.  They are still the majority and they have been wrong as hell since teh crash...

But... my fear is that a rising interest rate environment creates literally 10 years of non-appreciation for CRE.  See what I mean?

So ... is CRE destined to crash?  varies by location of coruse, and property selection, but I dunno...  doom and gloom predictors aren't likely to be the winners over the next couple years as they are not historically usually the winners and they won from 07 through early 09, but...


if one can't get out at a profit in the next 5-10 why buy?

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#8) On March 24, 2010 at 11:45 PM, checklist34 (98.89) wrote:


     Barrier to entry is def higher in CRE, but...  history favors stocks, and ... CRE hasn't faced a rising interest rate environment in decades, literally, and that environment can't help it.

      The advantages you describe are very real, but...  I am not sure, at this time, that they outweigh the downsides.  I am not stating that they don't, I am just thinking out loud...

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#9) On March 24, 2010 at 11:46 PM, catoismymotor (< 20) wrote:


Thank you for your thoughts and ideas. I've never owned any rental property. It might be the right thing for me in the far flung future. I should add investigating this idea to my list of things to do.


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#10) On March 24, 2010 at 11:53 PM, checklist34 (98.89) wrote:


    yw.  hopefully this list of pros and cons is helpful to somebody or other.  !


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#11) On March 25, 2010 at 12:03 AM, catoismymotor (< 20) wrote:

I've found it helpful. I am intrigued by the idea of owning commercial real estate. Until I do a ton of DD I will have no real idea if it would be the right direction for me. At this time I have my LTBHs stocks to keep me occupied.

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#12) On March 25, 2010 at 12:07 AM, checklist34 (98.89) wrote:

I am not sure if its the right direction for me...  and I've been pondering it for months...

its a challenge.  maybe more difficult than the equity markets for potential investors. ...  hopefully the right choice hits me...

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#13) On March 25, 2010 at 12:29 AM, Momentum21 (98.05) wrote:

a rising interest rate environment becomes a buying opportunity for those who are well capitalized. those in the game now will benefit from the fact that few will get in later and the supply side will slow down in direct correlation with rates/inflation. appreciation of the existing property should increase in an inflationary environment and your NOI will also increase significantly...multifamily housing is a segment of CRE that I think will benefit most in the coming years. every downtick in the homeownership rate will lead to a huge increase in the number of renter households...and my bet would be we don't see 69% homeownership for many many years to come.

there is also generation Y moving into the prime renter age...that demographic hasn't just begun to hit. I am not talking late night, no money down deals...if you have money to put equity into a deal or can bring the capital to the table I think there will be more opportunities coming down the road.

rising interest rates will shake those opportunities out pretty quickly. 

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#14) On March 25, 2010 at 12:41 AM, AltData (32.16) wrote:


I do think CRE is worth looking into, but instead of trying to operate directly, I prefer to look for well managed REITs that work with CRE.

A few I've been looking at are PLD, RSO, & RWT.

The REIT Message Board is a great place to find knowledgable people with experience with REITs.

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#15) On March 25, 2010 at 12:43 AM, AltData (32.16) wrote:

After posting that I'm not sure if my link worked. Here it is again.

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#16) On March 25, 2010 at 12:56 AM, AltData (32.16) wrote:

I should also mention the message board that deals with it more directly as you've been thinking about.

Real Estate Investing

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#17) On March 25, 2010 at 9:13 AM, JakilaTheHun (99.91) wrote:

Great blog, checklist.  Thanks for all the info on investing in CRE. 

I honestly can't see any reason to invest in CRE *right now* when you can buy commercial REITs at greatly discounted prices.  REITs are very liquid and many have experienced management teams that have been in the industry for awhile.  You might have to pay dividend and CG taxes, but I'd much rather turn a profit and pay those than lose money and pay no taxes.  

The balance may change here in another few years, however.  We'll have to see.  If REITs keep charging upwards and we see more loan defaults in the CRE sphere, there could potentially be some big bargains in that arena.  

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#18) On March 25, 2010 at 9:25 AM, Melaschasm (< 20) wrote:

Great discussion on Real Estate. 

Another disadvantage of CRE is the possibility of losing more than you invest. 

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#19) On March 25, 2010 at 10:44 AM, Griffin416 (99.97) wrote:

I would like to add something here. RE is the greatest investment ever...for those who are willing to do it the right way. My business is running multi-families for a living. I work for a private RE investment firm and manage 1200 units. The reason most people do not make a lot of money in real estate is because they do not understand that is a business, you need to understand the ins and outs of it, else you are just another speculator similar to the tech bubble stocks. For those who are willing to learn, speak to an accountant, a finance guy, then hire a mgmt company to run your property so you don't have crazy tenant knocking at your door.

People need to forget about appreciation when underwriting a property for sale. You need to factor in the cash flow, debt service, depreciation, some vacancy, expenses plus emergency expenses and then drag all those figures out 10 years to see if it makes sense. On a small scale, I find that to make cash flow the property needs to be at least 3 units (3 units should break even with about $100 cash flow)

The things I would stay away from is office/ industrial space, this thing has lots of room to come down yet. Multi-family is getting interesting now and when not staring at stocks all day (hehe)  I am analysing properties for sale. Some areas are ripe and some are still unrealistic.

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#20) On March 25, 2010 at 2:07 PM, lemoneater (57.18) wrote:

@ #6 I'm curious as to why the floor must be rebuilt when there was a meth lab on the premises. That does explain why the old house in my neighborhood has its floor completely gutted now since the renters had meth as their "cottage" industry.

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#21) On March 25, 2010 at 3:39 PM, truthisntstupid (87.04) wrote:


I'm guessing it's more than just the floor.  Probably the walls and ceiling, too.  They all get permeated with toxic chemicals.  When the temperature and humidity are right, the areas of drywall that've absorbed them turn colors as the iodine stains become more prominent.


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#22) On March 25, 2010 at 4:20 PM, lemoneater (57.18) wrote:

Thanks for the explanation, truth.  

No wonder why the owner even tried to give away the home for free, but didn't have any takers for the longest while. A neighbor got it but found out the city was requiring him to hire a contractor to repair it.

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#23) On March 25, 2010 at 6:40 PM, belfairinvestor (28.85) wrote:

Truth and Lemon;

My greatest real estate home runs have been condemned meth labs. The "clean-up" requirements are unbelievably expense, even though the extent of the "clean-up" is usually just painting over the symptoms. Its a scare tactic like lead paint and asbestos. Yes in large quantities its toxic, but a little won't hurt. You just have to be careful of the used needles, they're sharp. The property owners just want to be rid of the mess, and yes I am a construction contractor. I love rehabbing meth labs.

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#24) On March 25, 2010 at 7:05 PM, truthisntstupid (87.04) wrote:


 I don't know how much is overreaction and scare tactics, but I once lived in a mobile home that had once apparently had meth cooked in it. It's pretty disconcerting when vivid red and pink stains appear and disappear on the walls and ceiling at random and it's kind of eerie.  I guess I didn't suffer any ill effects, though.

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#25) On March 25, 2010 at 7:48 PM, belfairinvestor (28.85) wrote:


Let me elaborate. I would never ever live in a building which had meth manufactured in it, unless the appropriate clean-up(paint) was performed.

I have lived in 2 former meth house/property. I completely remodeled; demolished to foundation, one of them. The other is my current location where the old lady rented a detached garage  for an autobody/methcookhouse business. Ive since converted the building to my company office. 

Thats all from me as I don't want to hijack one of my favorite blogs with a discussion about lowlife tweakers. Sorry Checklist. 

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#26) On March 27, 2010 at 5:53 PM, checklist34 (98.89) wrote:

No need to apologize for the meth discussion, as I think its an important part of this discussion!  I don't honestl know if I could ever stomach owning a residential rental property for that basic reason, and similar reasons.

College kids (I was one once) spilling and puking and boozing and burning and staining everything in sight.  Someone cooks meth and my understanding is, per state law, you will have to replace the entire suite it was done in (walls, floors, ceilings, tear it out and replace it) and possibly the hallways and more.  I can only assume you can't exactly go after the meth cooker for your losses.

Stuff that rents to businesses seems more palatable.  

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