Brick by brick: Building wealth with commercial real estate

Whether you’re seeking steady income, long-term growth, or a strategic way to pass wealth to future generations, commercial properties can play a pivotal role in your financial strategy.

Adam Doud, Senior Specialty Asset Advisory Specialist at Wells Fargo Bank, N.A., says, “There’s always opportunity in the real estate markets — you just have to adjust expectations and your strategy to fit the current environment.”

Why consider commercial real estate?

Potential income and capital appreciation

Commercial properties have long been valued for their ability to deliver steady rental income, which can help investors weather market volatility. Over time, these properties generally appreciate, offering the potential for capital gains when sold.

“Real estate isn’t correlated to the stock market, making it a powerful tool for diversification,”^Footnote1 says Doud. This diversification helps balance portfolio risk and hedge against inflation while building generational wealth.

Tax considerations

Beyond income and growth potential, commercial real estate offers compelling tax benefits that can enhance your overall return. Recent legislation has preserved 1031 exchange’s key tax benefits for real estate investors which allows investors to defer capital gains taxes by reinvesting in new properties.

Doud explains, “If you sell a property for a profit, you can defer the taxes on those gains by purchasing another property within a set timeframe.” This allows investors to keep more of their money working for them, rather than paying taxes right away.

Another strategy Doud flagged is cost segregation, which accelerates depreciation by breaking down a property into components. For instance, by separating out items like carpeting or fixtures, you may be able to write off their value faster, which can help lower your taxable income in the early years of ownership. However, Doud advises the importance of consulting with a tax professional to ensure this strategy aligns with your financial goals.

Estate planning strategies and wealth transfer

Commercial real estate can also play a pivotal role in estate planning strategies. By placing real estate assets in trusts, families can manage income distribution and preserve wealth for future generations. “It’s much easier to divide the income from a portfolio of properties than to split physical assets,” explains Doud.

For example, a trust can hold multiple properties and distribute rental income according to the terms set by the grantor, ensuring each beneficiary receives their share without the need to sell or subdivide the physical assets. Furthermore, placing real estate in a trust can help manage estate tax exposure and facilitate a smoother transfer of assets. Doud notes, “If you own these properties at your death, you get a step up in basis on those properties,” which can significantly reduce the capital gains tax burden for heirs.

Challenges and considerations

Doud says, as with any investment, real estate investments are sensitive to changes in the market and economy.

Higher interest rates mean it costs more to borrow money for real estate investments. As a result, investors should be careful — adjusting what they’re willing to pay for properties and what returns they expect. In addition, fewer transactions are happening right now because property prices haven’t adjusted to fully reflect the higher borrowing costs.

Another consideration is during periods of economic slowdown, demand for real estate may decline, leading to longer vacancies and higher costs to address them. When the market softens, tenants, in addition to paying lower rental rates, may also demand more concessions in the form of free rent and higher tenant improvement allowances. Brokers representing tenants may also command higher commissions.

Market supply changes resulting most notably from construction deliveries can lead to lower rent prices when supply is delivered into a down market.

Doud also advises that real estate investors should always be prepared for a disruption in rental income. “These assets don’t typically transact quickly, and there are a lot of different factors that can impact income stream from a property,” says Doud. “Discipline and long-term thinking are key to weathering these changes and help preserve your portfolio.”

Strategic guidance

For those considering commercial real estate, Doud offers three key principles:

1. Don’t try to time the market. Focus on long-term strategy rather than short-term fluctuations.
2. Develop a responsible investment plan. Consider your overall wealth and portfolio concentration.
3. Execute with discipline. Do not underwrite aggressively, take on excessive debt, or sacrifice asset quality to chase desired investment returns.

For more information on how real estate can play a role in your wealth plan, talk to your advisor.