Finding stable, high-yield and long-term investments in today’s turbulent market is difficult. With the Fed having started work on hiking interest rates, bonds are not the answer, meaning investors have been forced to look elsewhere, with a view to finding safe, stable and long-term returns.
High-income producing commercial real estate may be the ‘cash cow’ to meet these criteria for any investor looking to add to their portfolio. Armed with a master of philosophy degree in financial economics from the London School of Economics, and following decades working in investment banking, primarily in London, I have returned to my place of birth, Tennessee, to invest in and sell income-producing commercial property located in the southeastern US.
The region is by no means the first place most global real estate investors look for property; indeed, the vast majority look to major US cities such as New York or Los Angeles for opportunities, of which there were plenty in days gone by. However, these markets are becoming increasingly crowded and overbought.
REIT minimum level
The stable southeast
Real estate in most urban areas in the southeastern US, meanwhile, is relatively stable and hasn’t undergone the huge swings in value throughout the 2008 to 2015 period. Taking into account this added degree of stability, the speculation of rapid value appreciation will not compress the cap rates (the return on an income property which is net operating income divided by purchase price), as it often has done in more volatile markets. Cap rates on some properties in major markets, London and New York (see Fig. 1) for example, are trading as low as three to four percent, whereas southeastern urban areas are trading in a range closer to eight to 12 percent.
There are three areas that are of key concern for international investors: lack of knowledge in local markets, tax implications, and risk of fraud. One of the easiest ways to mitigate this first concern is to invest in a fund that possesses the local talent and knowledge.
There are many real estate investment trusts (REITs) in which to invest, and these institutions sell shares and invest in commercial real estate, with the majority of the net income paid out to the investor. Under US tax laws, no taxes are paid at the REIT level, and the benefits of REITs in the main are that they provide expertise, diversity and liquidity for any listed on a major exchange. They also pay a steady dividend, typically ranging from three to eight percent. However, the management team is paid hefty fees for its services and, given the size of most REITs, they only invest in properties that sell for over $25m. REITs have experienced large capital inflows over the past few years, which is one of the driving forces compressing returns on large commercial properties.
When it comes to finding local expertise, my advice is to find a local partner that knows the lay of the land – preferably one with ‘skin in the game’ – and co-invest with them. Many family offices are taking this approach. Usually two or more wealthy families will co-invest in a project or projects where the local family will receive a fee for the management of the property. This is beneficial partly because the partnership is pari-passu – in other words, they share equally in the risk and rewards. These families are able to invest in properties that are below the REIT minimum levels ($25m), and in doing so they’re able to find higher yielding properties.
Direct investing gives one full control, greater transparency and, potentially, greater returns. It can be very rewarding with cash-on-cash returns in excess of 20 percent per annum, although there are three primary elements to consider when it comes to investing in real estate: acquisition, funding and managing.
Firstly, the purchasing of the property requires local knowledge and one should engage with a broker affiliated with a reputable firm, and one that knows their market well. It is important to ensure that the broker represents the buyer’s interests. As far as funding is concerned, one can pay all cash or leverage one’s investment. Local banks in the southeastern US are bulging with money waiting to make its way to local properties. They are required to lend a certain percentage of their balance sheet to local projects and many are willing to lend up to 85 percent of the purchase value, providing great leverage in this regard.
An eye on investment
In terms of management, there is an abundance of local professional property management firms in the area. Additionally, with today’s technology, it is easy to install on-site cameras in order to keep an eye on the investment from anywhere in the world. It’s important to note also that there are triple-net-leases: a term used to describe a scenario in which the tenant is responsible for all the maintenance, taxes and insurance. Hence the term triple net.
I am not necessarily a tax expert and cannot give tax advice. However, most major nations have their own tax treaties with the US to protect against double taxation. Even still, the US the government allows investors to sell their property and buy another property of equal or higher value without paying any capital gains tax. This roll over benefit is called a 1031 exchange, and US property investors often use this method to defer any gains on the properties they sell.
On the subject of fraud, the best way to mitigate damages on this front is to have the proper checks and balances in place. With US real estate, most buyers will purchase a buyer’s title policy. This insures that if there is a problem with the title at any time, the title insurance company will reimburse the buyer. This is a small fee and most buyers will choose to purchase the title insurance. Real estate firms in the US are licensed and regulated by each state plus there are established ways of structuring the accounts to mitigate fraud risk. Also, if one purchases a ‘triple-net-lease’ property, there is no need to employ a manager.
As with any investment, there are risks and rewards both, some more so than others. Income commercial properties, ranging from $500,000 to $25m in the southeastern US can offer stable returns and are well worth considering for any seeking to supplement their alternative assets.