After being completely immersed in this business for numerous years, we made it a priority from the beginning when conceptualizing our business model, platform and process to make sure we listened intently to our most successful clients. Maintaining this strategy over the years, we have been able to glean complete clarity in what most of our most successful investors did and what many are doing today to build and preserve their wealth while mitigating risk.
We thought we would take a moment to share these extremely valuable principles with you.
Top 10 Common Denominators of Our Most Successful Commercial Real Estate Investors
1. Time the Market for All Transactions:
Simply put, sell at market peak value which is often 2-3 times per generation. Purchase during value valleys in economic challenging times that provide opportunistic and fortuitous acquisition cost/value.
2. Ensure Solid Level of Liquidity and Buy Using all Cash and Finance After Closing:
When investors purchase with all cash, they can limit their competition during pursuits of assets, often in a challenging economic climate where debt rates are elevated and / or debt supply is limited.
This ensures quick and aggressive timelines and improves the probability of being selected by the seller, particularly during recessionary times or during any of the seller’s economic headwinds.
3. Use Leverage to Maximize After Tax Income; Simply Put, the Advantages are Enormous:
The entire interest expense is tax deductible. This is particularly advantageous during the first several years of a loan as the interest amount is the majority of the mortgage payment. Further, leveraging some of the benefits of real estate as an investment vehicle include depreciation of improvements, which can show significant benefit especially with a cost segregation strategy. See more detail below on item 6 of this list.
4. Have Lenders Compete for Your Business:
Let the best lender win! We always recommend our purchasers acquire at least 6-8 quotes from respected lenders. Our internal capital arm, Marcus & Millichap Capital Corporation (MMCC) sends our clients’ property underwriting to the 10-12 most suitable lenders. They then not only compete against one another, but also are pitted against the principals’ preferred lenders. This process most often produces incredible results, (with MMCC winning much of the business due to the leveraging of their lending relationships coupled with the competition process) often reducing the rate by up to 50-80 basis points, while also increasing the loan to value percentage (in many cases up to 75%) and elongates both the loan term and amortization schedule timelines to 25 or even 30 years. This makes a massive difference in increasing and maximizing the cash flow after debt service (CFADS) during the hold period for our clients.
5. Purchase Properties with Below Market Rents:
This will ensure real estate appreciation and upside through the ability to increase rents, while also providing a true risk mitigator if the economy shifts and tenants’ businesses volume decreases. During turbulent economic times, higher rents can often be challenging for tenants to maintain, which presents the risk of vacancy. Identifying below market rents helps provide further assurance of the highest level of occupancy long term. Additionally, during strong economic times, this enables landlords to recalibrate rents and turn over weak unstable tenants.
6. Use of Depreciation:
This tool is key for successful commercial real estate investors to reduce their basis and enjoy a significant after-tax savings of their overall income. Additionally, we also prescribe and work in tandem with the industry’s top deprecation specialists to assign accelerated depreciation through cost segregation. This underutilized strategy front loads enormous tax savings and is in particularly valuable for high-net-worth investors who have large income levels to offset. The benefit depends on the purchaser’s specific tax situation and specifics of the asset in particular, but through cost segregation, most assets can help a new owner offset their tax liability by 30-40% of the asset’s improvement value as a tax write off in the first year of ownership.
7. 1031 Exchange:
Astute investors use the 1031 exchange tax benefit to ensure they do not experience significant tax penalties and consequences when they sell their commercial investment asset. Over time, an investor’s basis becomes depleted and most often, when selling, there is a significant profit from the sale proceeds that would be subject to both recapture tax and capital gains taxes. In most cases, these tax implications are substantial. By performing a 1031 exchange, the seller is able to postpone the tax penalties and carry over the bases to their new acquired property. In addition, they can step up their basis by leveraging their proceeds into an overall larger portfolio value allowing for a higher level of future equity build up, appreciation, and higher basis to perpetuate a depreciation strategy offsetting tax liabilities in the short term. This pathway is not complicated, but it is complex. Because of the enormous tax advantages and benefits the members of our team have become true industry experts in this strategy and have designed an array of sophisticated processes and methods to maximize the results of this endeavor.
8. Purchase Properties in High Growth Trade Areas:
Smart investors always investigate and ensure that the sub-markets and surrounding trade area is desirable, has solid forecasts for population growth and positive projected population migration. This ensures demand, growth and appreciation of rents, income and overall future increases in equity for the asset.
10. Location, Location, Location:
While the lease, lease term, credit, and trending pattern of the current tenant is important, it should always remain a secondary consideration in line behind the number one commercial real estate fundamental of selecting a property based on location. There are a dozen and a half additional specific critical characteristics and location sub factors that are examined and measured to best judge the location. There may never be a “perfect” investment property, but having a checklist for core real estate characteristics helps ensure you are not only buying a solid cash flow stream, but also a long-term viable investment property for the future.
11. Annual Rent Increases:
Annual base rent increases are fairly common with shopping center leases, but not so prevalent in single-tenant, net-leased properties. When we orchestrate opportunities for our investors through sale leaseback transactions, which we facilitate a substantial volume of, we routinely successfully negotiate annual rent increases into the lease structure. While this has not been a pressure point in the low inflationary climate we have experienced over the previous 6 years, (during the past 6 years, the CPI ranged from 1.3% to 1.7%), this becomes an extremely important factor in Today’s hyper inflationary environment to ensure the pace of rent increases and income appreciation outpaces the annual inflation rate. The current hyper-inflationary environment (highest in 40+ years) with inflation rates currently at 9+% in the past 12 months. This aspect is absolutely critical to ensure an investor does not purchase a property that has a true Achilles heel or becomes a highly depreciating asset.
The above specifics are relatively brief for each of the ten most effective strategies our most successful clients focus on in regard to their commercial investment property. Our team prides itself on assisting our clients in building stable, consistent wealth while simultaneously ultimately mitigating the myriad of risk factors that are inevitable considerations with these assets. There are many additional nuances to each of the top ten listed above and there are certainly at least another ten secondary sub strategies that our most successful investors utilize consistently.
We are happy to share these additional intricacies and strategies with you personally to enhance your investment results. Please contact us to best understand how we many assist you in your quest of wealth building through commercial real estate ownership and transactions. We look forward to speaking soon!