Did you know that commercial real estate is considered a major asset class just like stocks and bonds?
In order to understand this, it's important to first point out that commercial real estate is actually comprised of three separate markets: the "user market" (i.e., tenants and owner-occupants looking for space), the "capital market" (investors looking to invest funds), and the "property market" (supply and demand). An active user market is the demand for commercial real estate. Where there is demand, money from the capital market is likely to flow to it, thus creating a supply of commercial properties available for sale or lease. This supply and demand creates the property market.
Looking at the behavior of these markets, you can see why commercial real estate competes directly for investor dollars with other investments. When the expected risk and return of real estate is competitive or greater than stocks and bonds, the capital markets will invest in commercial real estate. When demand for commercial real estate is down, you can expect capital to flow into stocks, bonds, mutual funds, and the like.
Commercial real estate also behaves like both stocks and bonds. A commercial building with a strong lease in place will have the coupon payment features of bonds, while hopefully appreciating in value and like stocks. According to the CCIM Institute, unleveraged commercial real estate should provide returns that settle somewhere between stocks and bonds. The risk profile of commercial real estate should also usually be considered to fall somewhere between stocks and bonds.
This is a simplistic view, of course, as the individual risk and return profiles of one stock or bond vs. another can and do vary, just as the performance of one commercial building can vary from one right next door. The point is, the risks and returns associated with a commercial real estate purchase should be carefully analyzed just like any other asset. After a thorough analysis, we may find that it makes more sense for you to lease space than to tie up capital in real estate that could be used for other, more attractive ventures or investments.
Need a second set of eyes on your commercial real estate investment analysis? We can help.
Posted by Chris Cole