February 5, 2014 Neil warshafsky

Retiring Rich With Commercial Properties

301Commercial investing may seem unconventional to some, but it does have the potential to generate some long term profits. Neil Warshafsky explores how a commercial portfolio can help you build your retirement savings

Forty is the new 30. Our jobs, buying a home, and growing a family fills most of our lives, and may leave little time for retirement planning. Now that we’ve made it well into adulthood, before long, a landmark like a grown child’s graduation or our own 40th birthday reminds us to plan ahead if we want a rewarding retirement with financial stability.

THE SCENARIO

Retiring Canadians will need to generate $750,000 or more in personal wealth, aside from your residence, to secure an annual income of $50,000 or more. Historically, more financial wealth has been gained through real estate than any other investment. Funding retirement through commercial real estate provides an accessible private equity investment strategy to ensure a comfortable life, even while celebrating 80th birthdays and beyond.

 

Your residence is often the first property to launch your investment plan. This is not surprising, since, according to the 2012 Bank of Montreal Retirement Institute Report, “41 per cent of Canadians consider equity in their home an option to save for retirement… 47 per cent of Canadians said their home or primary residence is their biggest financial asset, and on average it accounts for 51 per cent of their total net worth.”

Your commercial real estate investment strategy can be applied just as well from cash on hand, but most Canadians will find their current wealth lodged firmly in their own homes when they begin to save in earnest for retirement. Using your home equity to create your future financial security makes sense for Canadians.

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THE STRATEGY

One may choose to invest more aggressively for higher returns, yet here is a relatively low-risk path to financial independence. By buying three and selling two commercial properties during the next five years, you can acquire $1 million in equity from an $85,000 investment, This will provide both an annual income of $50,000 in 25 years, along with a million-dollar commercial real estate asset. Equity gained from a residential property purchased 10 or more years ago is now in the 100 to 200 per cent range, often higher, in most cases providing $75,000 – $200,000 in current equity that can be borrowed against to reinvest into an income generating commercial real estate portfolio. With a home equity loan of $85,000, you can launch your retirement plan by purchasing a small commercial property. The third purchase necessitates a 20-year mortgage amortization. During the same time period, rents would have been incrementally adjusted for inflation, raising the property’s annual after-expense income, or net operating income (NOI), to $50,000 to $60,000 which becomes income with your mortgage paid out after 20 years and a meaty ROI that will adjust with inflation for years to come. For gravy, rising property values will have raised your $750,000 purchase to an asset worth in excess of  1,000,000.

WHY CHOOSE COMMERCIAL REAL ESTATE?

With growth determined by market gains, a higher return on investment (ROI) to residential real estate is common. Commercial real estate also affords more methods of increasing property value, through factors like changing to a more suitable use, rent increases, superior tenants, and physical alterations. Some investors also prefer the heightened formality of commercial real estate management for both the investor and tenants, who do not regard the leased property as a home, but as a professional space facilitating livelihoods. Commercial leases generally require tenants to pay all operating costs of the property they occupy, allowing the real estate investor to protect their asset with fees associated with any capital improvements that benefit tenants, such as heating and cooling systems, and with  incremental increases to cover rises in utilities, property taxes and other costs not usually recoverable from residential tenants. Investors may choose to purchase commercial properties and hire property management companies, to invest in REITs, or both. While outright ownership tends to create greater wealth, each strategy offers long-term gains.

One may choose to invest more aggressively for higher returns, yet here is a relatively low-risk path to financial independence

Canadian commercial real estate’s sustained growth is fueled by the rise of investment syndications and in mass corporate ownership, along with immigration and population growth. The Greater Toronto Area (GTA), for instance, is expected to grow by 2.6 million residents by 2031. Fresh foreign capital and a growing domestic economy means demand for commercial property will remain steady, keeping conditions favourable for investors.table_e26

Canadian Real Estate Investment Trusts (REITs) were given a boost when the Bank of Canada lowered the prime interest rate by one per cent in 2009. REITs have maintained double digit returns over the past four years. REITs help keep demand for commercial property stimulated since they do not tend to liquidate real estate assets, but maintain ownership to finance even greater property acquisition. For the next several years, demand will continue to outpace supply in Canada’s commercial realty market.

 

 

FINANCING FACTORS

When entering the commercial real estate market, first-time investors need to understand the financial characteristics of each purchase. Commercial investing requires a more comprehensive grasp than residential investment does in the areas of financing, leases, maintenance, zoning, environmental factors, and even legislative and taxation aspects. Along with their commercial real estate broker, investors are well-advised to begin building a network that includes a lawyer, financial planner, accountant, environmental experts, physical inspectors, and mortgage brokers.

Familiarise yourself with the variety of commercial properties. Currently, of the top tiers, office space lease values are on the rise across Canada, largely due to falling unemployment rates. Retail space grows increasingly competitive, partially due to recent expansion by major U.S. retail chains, as we have seen with the American retailer Target, which has effectively displaced most Zellers department stores. Industrial properties are seeing a slower growth rate and not quite the spike in value enjoyed by retail and office spaces, yet warehouses around the country are reporting high occupancies and very limited vacancies of three to eight per cent in major cities.

The capitalization rates (cap rates) of various commercial properties help investors determine properties that best suit their needs. In commercial real estate, there is a direct line between the risk and reward. Cap rates reflect the full scenario of values, including the type of property, income and leaseholders, size, age, location, financial covenants, environmental and other factors. Typically, lower cap rates  indicate safer investments.

TAX BRACKET

One of the most advantageous aspects of property investment is that real estate profits are not taxable until the property is sold, while expenses related to owning the property are tax deductible, including mortgage payments.  Unlike 100 per cent taxable gains from GICs and bonds, real estate capital gains are taxed at just 50 per cent.

You can also cash out some of your real estate profits without incurring taxes by refinancing the real property with a new mortgage, then reinvesting the tax-free profits into your new property, allowing your commercial real estate investment to grow annually, tax-free, compounding value for your retirement.