Every week, we ask a real estate professional for their Short List, a collection of tips and recommendations on an essential topic in real estate. This week, we talked with Gary Carmell, the President of CWS Capital Partners, who shared the top benefits of real estate for investors.
Real estate is the one investment category that every individual must use in some form or fashion in his or her lifetime. Whether as a place to live, an office to work in, a store to shop in, or a place to store some of our larger possessions, real estate will always be in demand. This has historically made real estate a very good way to store, preserve, and grow wealth. This is the case for well-located properties that are maintained well, because real estate is typically a byproduct of economic and demographic factors. The United States, particularly in dynamic cities with a well-educated workforce, is able to innovate and grow over the long term, despite periodic setbacks. Real estate naturally benefits from this growth. Here are some ways to find the most value:
- You Value Illiquidity: Illiquid investments have a better potential to allow one’s capital to compound by having it invested longer in strong real estate investments with durable cash flows that the sponsor (like CWS Capital Partners or others) controls.
- Tax Benefits: Real estate can be an excellent estate-planning tool. Distributions made over the years, along with depreciation deductions, build up an increasing potential tax liability when it comes to time to sell. This makes using the 1031 exchange a very powerful and attractive wealth-preservation vehicle.
- Leveragable Asset Class: Most commercial real estate loans are nonrecourse, meaning there is no liability to the borrowers for repaying the loans, provided no illegal acts were carried out that would result in a loss to the lender. The lender can only look to the collateral of the property or other pledges made by the general partner or affiliate. The purchase of a larger property using borrowed money allows for more depreciable assets per dollar investment, thereby providing more shelter of one’s distributions from immediate taxation. The right lender and loan structure, however, can allow for the advance of this additional capital.
- Yield-oriented Investment: Real estate is typically purchased to generate current dividends that are typically higher than what is available in the stock or bond markets. This is the case because most properties are limited in terms of expanding their capacity to generate more revenue in any way other than by raising rents. It is rare that more units can be created. Given this, real estate investors tend to want approximately half of their total return to come from dividends and the rest from capital appreciation.
- Tangible Asset: Owning property is obviously tangible and is unique because of the owner’s ability to improve upon it and add value.
- Potential Inflation Hedge: Real estate has generally proven to be a hedge against inflation. As excess money is created, it needs to find a home, and real estate is one of the most desired asset classes when this is the case. Apartments are particularly well suited, because the average lease term is approximately eleven months, so it’s easy to reprice the apartments in an environment of escalating rents given the relatively short lease terms, especially when compared to office, retail, and industrial properties.
- Lacks the Volatility of Daily Pricing: We value our investments once a year as compared to freely tradeable securities whose prices fluctuate minute by minute. Not worrying about daily valuations can take a lot of the emotion out of investing and allow one to focus on adding value each day without being distracted by highly volatile market fluctuations.
- Direct Control of Cash Flows: I believe that having directly owned and managed properties over the years has made the men and women of CWS Capital Partners much better decision makers and businesspeople. We have to deal with real-world problems, rather than evaluating management teams from afar as many stock and bond portfolio management teams do. We are more grounded and can use our vast amount of experience to evaluate opportunities and risks and separate the signal from the noise. We can also take direct action to add value to our investments, because we control the cash flows.
- Future of Apartments: We’ve talked a lot about the advent of the renter nation at CWS for a number of years. When the housing bubble was in full force, we were pretty sure that there would be a day of reckoning, as loans were originated on a huge scale to individuals who had very little margin of safety if their income were interrupted and/or home values declined. Sure enough, the house of cards collapsed, and the housing market went down in flames. My new book shows graphs that highlight new single-family sales going back to 1959 and existing home sales (resales) going back to 1999. We can see how frothy the housing market became for both new homes and resales from 2003–2007. New home sales subsequently collapsed and remain at depressed levels. Meanwhile, the mortgage market remains tight, the price of many resale homes is low enough to discourage the building of new ones, the labor market is soft, and consumer psychology is weak.
Unfortunately, incomes have not been rising meaningfully, as more of the economic output is accruing to capital in the form of profits and dividends. As the average required credit scores have risen since the downturn, the trend does not look very favorable for first-time homebuyers to enter the market in any meaningful fashion. They’re generally lacking the credit, down payments, and incomes. This should keep people renting longer than they otherwise would, especially combined with the other factors cited previously.
Apartments have proven themselves to be an asset class that has staying power. While individual properties can face obsolescence and deteriorating location fundamentals, renting will always be in demand. And from what I can tell, the demand fundamentals should remain quite strong for a number of years to come.
Gary Carmell is the President of CWS Capital Partners, a real estate investment management firm based in California and Texas, and founded in 1969. He specializes in the acquisition, development, and management of apartment communities throughout the United States, where his company owns and operates more than twenty thousand units with a value of over $3 billion. Carmell can be reached through his website www.garycarmell.com, and through LinkedIn and Twitter. The Philosophical Investor is available for purchase on Amazon and other fine booksellers.