Investing in real estate can help better diversify a portfolio and help generate predictable income, but comes with its own set of risk factors.
What are some of the potential benefits real estate investing can help bring to your portfolio? Here, Stephen Thomas and Scott Bennett, Real Estate Advisory Specialists with Wells Fargo Bank within the Wells Fargo Wealth & Investment Management division, share their insights.
1. The potential for a steady revenue stream
Thomas recently worked with a trust client who used proceeds from the sale of vacant land in North Carolina to acquire four commercial spaces elsewhere. As a result of this real estate investing, his client is now receiving a steady stream of revenue (primarily from rent) that he wasn’t receiving before. As reported in The Wall Street Journal early in 2021, 10-year bond yields reached historic lows as the pandemic took hold in 2020, which made it more difficult to generate lower-risk income. Hard assets, including commodities, art, or even a piece of vacant land lacked ongoing revenue streams. That’s where investing in commercial real estate may help.
“Income is one of the key components when considering investing in commercial real estate,” says Bennett. “Based on our experience, high quality, well located properties leased to tenants with strong credit have continued to perform well during the COVID-19 pandemic. This is precisely the reason that some investors turn to real estate during times of economic uncertainty.”
2. More potential tax benefits because of tax reform
In the case of Thomas’ client mentioned above, those real estate transactions fell under a series of 1031 exchanges, which allowed deferral of capital gains taxes on the sale by reinvesting in another qualifying property. The Tax Cuts and Jobs Act of 2017 also created the Qualified Opportunity Zone (QOZ) program that allows tax deferment, while Section 199A’s deduction may help reduce taxes for pass-through entities such as S Corps, partnerships, and LLCs, which are typical in commercial real estate investing.
“There have always been potential tax benefits to owning real estate,” Bennett says. “The 2017 tax reforms made commercial real estate even more attractive from a tax efficiency standpoint. Our expectation is that the majority of the tax benefits currently available to real estate investors will remain intact under the Biden Administration.”
3. Another way to diversify your portfolio
As you consider any exposure to commercial real estate, both Bennett and Thomas suggest keeping your portfolio diversified by mixing your commercial real estate investments with stocks, bonds, and even real estate investment trusts (also called REITs).
“Today, many investors are looking for ways to diversify their portfolios, generate income, and manage their tax burden,” Thomas says. “Real estate investing can help with all of those things.”
Bennett adds: “Broadly speaking, the equity markets have rebounded since the March 2020 downturn, and based on projections from Wells Fargo Investment Institute1, they are once again priced at healthy levels after 10 years of providing strong returns. I believe that it’s vitally important, always but especially now, to stay diversified,” he says.
One more thing to keep in mind: directly investing in commercial real estate is a strategy that comes with its own set of risk factors. The primary risk is that the underlying asset is illiquid and is not readily traded in the daily market, meaning it may not be as easy to sell an office building, for example, if you need to convert your investment to cash. Added to that is the unpredictability of ongoing costs that can be associated with owning real estate, such as maintenance, capital improvements, and leasing costs for commercial buildings. That unpredictability has been particularly relevant for building owners during COVID, and will continue to be as things move toward a “new normal.” However, there is potential upside, so be sure to discuss your objective with your wealth professionals before moving ahead.
“In our big picture view,” says Bennett, “adding commercial real estate to your portfolio offers a combination of diversification plus potential for income, appreciation, and total return. While real estate fundamentals have softened to some degree during the pandemic, those conditions can create buying opportunities. Assuming we get the virus under control and the economy on more sound footing, the real estate markets should follow.”
1Top 5 portfolio ideas for 2021, Investment Strategy Report, Wells Fargo Investment Institute, January 4, 2021.