Simple Commercial Real Estate Investments for Your Self-Directed IRA

By Ned Coyle, Commercial RE Investment Specialist

Have you considered investing in a commercial real estate property only to back-off because you didn't want the management hassles? OK, fair enough. Did you then invest those funds in the stock market, perhaps a Real Estate Investment Trust (REIT) because it was the easy thing to do?

No one has to tell you the direction your stock portfolio has taken, right? It probably has about the same value today as it did in 2002. Where would your net worth be today if you had taken a portion of those funds and invested it in real estate? We are not talking a REIT stock here but a purchase, in a fee simple manner, of a commercial office, retail or light industrial distribution property.

Why fee simple ownership? When you own a property “fee simple” – you, and no one but you, owns it. You are not investing in a corporation that issues stock to you along with thousands of others. Nor are you investing in a real estate fund such as a blind pool that buys what they want, when they want, at what price they want and convince you that everything is great.

Compare fee simple to that stock or fund. What is the value in that stock today compared to the underlying value of the assets? There is no relationship whatsoever and that is truly tragic!

A Problem

We have all read about the developers and owners of commercial real estate that are undergoing tremendous financial pressures with some being forced into bankruptcy. So what happens to their real estate? Well, the owner or lender puts it on the market at a discount to attract a solid, mortgage worthy buyer who can move quickly and close the deal. Unfortunately, you as an individual investor or partnership will never see these deals because they typically involve several properties valued at several millions of dollars. And why would you want them? If the current owner can't sustain them what magic can you perform?

The Solution?

However, there is one asset class that is outperforming the market that should be at the top of your list. I am referring to net-leased properties such as drug stores, bank branches, auto parts stores and dollar stores.

There are dozens of these properties available all over the U.S. that are new construction, leased to credit tenants on a long term basis - 10, 15 and 25 years is the norm. These are properties that you drive by every day. Some one owns them and you can too. Here's how you can become a landlord without the hassle of collecting rent and dealing with tenants.

The majority of these types of properties are built on a contract basis for the user by a developer. The user, say Walgreen's, signs a long term lease and the property is built and occupied. The developer needs the cash to build more stores so the newly constructed Walgreen's is put on the market for sale.

As other retailers are struggling to stay open, these businesses are defying the trend and are some of the most solid performers today. And the prices for these assets are being lowered to attract investors.

One way for an investor to evaluate a potential investment is to look at the capitalization rate or “cap rate”. The cap rate is a figure that attempts to quantify the value to the investor of a particular property. Generally speak¬ing, a pretax cap rate is the Net Operating Income (NOI), divided by the purchase price. Or conversely, the NOI divided by the cap rate will be the purchase or selling price. A property with strong key indicators will trade (sell) for a low relative cap rate reflecting the strength of the overall investment.

For example, asking capitalization rates for a fairly typical Walgreen's Drug Store twelve months ago were in the very low sixes. Today, the first of February of '09, the asking prices are pushing the seven cap rate range, with some higher. Translating that into a sale price, what was being sold a year ago for $6,100,000 can be purchased now for $5,360,000. Same tenant, same credit.

What this Means to You

The credit crunch has triggered widespread re-pricing in all sectors of the real estate industry. In general, the market has witnessed Class A property cap rates increase by 25 to 75 basis points while B and C property cap rates have climbed 50 to 150 basis points. For buyers of newly constructed net-leased properties with 10 plus year leases to credit tenants, well-capitalized buyers are finding that this is a great time to invest in net-leased properties.

What makes these properties so simple to manage? With a triple or double net lease structure the tenant is paying for all, if not most, of the costs of occupancy such as real estate taxes, building insurance and common area maintenance (e.g. grass cutting, snow removal and general maintenance to the heating and cooling).

These tenants also simplify the due diligence needed on your part. In almost all cases these are national corporations that continue to do well in spite of the economy. Drug stores, dollar stores, branch banks, auto and tire stores and auto parts stores, even fast food restaurants are all businesses to consider. Leases are typically 10 to 25 years and the majority of the properties being offered today are brand new construction. Since these are brand new, newly occupied structures, not much is overlooked before the tenant takes possession so your due diligence has already been performed.

If you are a professional without the time or inclination to devote to your real estate investment, but at the same time understand all the benefits of owning real estate, it should be pretty obvious that this property type suits your lifestyle.

Very simply stated, prices are coming down for even the best real estate, and net-leased real estate properties offer the investor a conservative investment strategy. As usual, the best practice is always KISS. And yes this also applies to investing in commercial real estate. Fee simple ownership, simple management, computer mailed rent checks, credit tenants and A+ locations make this investment type a pretty simple investment decision.

Disclaimer: Equity Trust is a passive custodian and does not provide tax, legal, or investment advice. It does not endorse or recommend any contributor, company, or specific investments. Any information communicated by Equity Trust Company is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with your legal, tax, and accounting professionals.