Is now the right time to purchase a commercial real estate investment property? Real estate is a popular investment industry because of the growth potential and consistent return, especially if done strategically.
There isn’t a simple yes or no answer as to whether now is the right time to purchase. Let’s discuss elements you should consider before investing in commercial real estate.
Opportunity Zones
Opportunity zones are one area of investment with high potential. According to the IRS, Qualified Opportunity Zones (QOZ) are “economically distressed [communities] where new investments, under certain conditions, may be eligible for preferential tax treatment.”
In order to qualify as an opportunity zone, the area must be nominated by the state, District of Columbia, or U.S. territory that is certified by the Secretary of the U.S. Treasury.
The goal of opportunity zones is to encourage economic growth and development in distressed communities. Investors who invest in CRE in opportunity zones receive tax incentives such as:
- Tax deferrals
- Untaxed adjustments of the investment after holding it for at least 10 years
Investors seeking to invest in CRE properties in opportunity zones do not have to live in the zones to qualify. The only requirement is to invest in the qualified opportunity zone property and defer the tax on the gain.
View a list of opportunity zones here.
What You Need to Know About Capital Gains Taxes
Proposed changes to the American Families Plan seek to adjust capital gains taxes from 20% to 39.6%—nearly double what it is now. The CRE industry relies on capital gains to produce profits, especially on fix and flip investments.
Imposing high taxes on capital gains has the potential to impact the CRE industry, and deter future investments.
Currently, Section 1031 allows tax deferrals on capital gains taxes if the property is a like-kind exchange. This means taxes are not imposed on profits gained from investment properties if they are used and invested in a new investment property within 180 days.
So, what does this potential tax change mean for the CRE industry? If implemented, single taxpayers could only defer capital gains up to $500,000 and married taxpayers could only defer capital gains up to $1,000,000. This elevates concerns for economic stagnation if commercial investors participating in like-kind exchanges, who account for 10-20 percent of commercial real estate transactions, do not sell properties because of taxes on gains.
Current Rate Environment
The Federal Reserve controls rates for banks to borrow money. These rates directly affect the terms and rates for commercial lenders—rising when the economy is strong and lowering when the economy slows. Consider the current market rate environment before investing in a CRE property.
At InnCap, we update our rates page daily in order to understand market rates as a whole when sourcing the best lending partner for your next capital venture. For commercial loans, we obtain capital for:
- Growth
- Acquisitions
- Recapitalizations
- Refinances
What Are the Benefits of CRE Investments?
Real estate investments work for your benefit, especially over time.
They offer:
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- Tax Breaks – Mortgage interest, operating expenses, and depreciation can be deducted as a tax write-off.
- Appreciation – While property value fluctuates, real estate value increases over time.
- Cost Stabilization – Rental prices rise over time through fixed increases or through the Consumer Price Index (CPI).
- Building Equity – Purchasing a CRE property and paying dues on time builds equity over time.
What Should You Consider Before Investing in CRE?
There are additional factors to consider before investing in CRE, including:
- Economic Recovery – After a year of fluctuating economic activity, the market seems to be stabilizing. Are you prepared for potential fluctuations?
- Down Payments – Typically, 10-25% of the property value is required for down payments. Is that a cost you can front?
- Financeability – Sourcing the right loan can make financing an investment possible. Is your loan rate and term manageable?
- Income Opportunity – CRE properties have the potential to generate income. Will the projected income of the CRE offset mortgage and other added payments?
- Prepayment Penalties – Some loans charge prepayment penalties if the loan is paid ahead of time. If you source a loan with prepayment penalties, are you willing to pay off the loan with interest over the fixed amount of time?
Investing in a CRE property offers investors benefits over time, but is a big choice. Consider the pros and cons between the benefits and drawbacks of investing now. Want more tips on real estate investing? Read our article on five elements to consider before purchasing your next investment property here.
