Numerous publicly traded real estate trusts (REITs) have faced challenges in the past year, with returns largely trailing stock market indexes. But REITs that are focused on ground leases — owning the land without owning the buildings that sit on it — have been an exception.

Splitting the ownership of commercial land from the buildings that sit on it isn’t a new idea. In some ways, it’s the same financial structure that medieval royalty used with its subjects. But the democratization of ground leases and their growing popularity is reflective of other kinds of securitization across the economy — creating narrower and more focused return characteristics to suit the needs of different classes of investors.

And with commercial office real estate, in particular, in a prominent state of post-lockdown upheaval, the ability to create a de-risked real estate asset has been warmly embraced by investors.

At present, Safehold (SAFE) is the sole publicly traded ground lease REIT pure play. It will likely be one of several on the market in the coming years, prompting other more traditional REITs to diversify their holdings with land leases.

We’ve already seen this with a mega-deal involving Realty Income and Wynn Resorts. In a transaction valued at $1.7 billion, Wynn Resorts sealed a sale/leaseback arrangement with Realty Income, a traditional REIT, for its Encore Boston Harbor development, a hotel, casino and theater project six miles south of Boston.

Unlocking capital when in need of liquidity

Property owners are using ground leases to unlock capital in areas where liquidity is lacking. With regional banking tightening up lending — even with the specter of lower interest rates — we are now seeing land lease inquiries shoot up. In my own land lease specialty practice, we are fielding more queries from owners and developers in all real estate sectors.

One needs to only look at numbers touted by Safehold. Tim Doherty, Safehold’s head of investments, said in a press release that the company has expanded land lease deals from 12 in 2017 to 130 in 2022, with the value of the portfolio at more than $6 billion. He attributed the growth to a new level of sophistication in the land lease market, adopting strategies such as predictability of lease payments, a move that leads to more efficient pricing. Over the last three months of 2023, Safehold stock was up nearly 40%.

Growing popularity of ground leases has not gone unnoticed. Three years ago, Dallas-based Montgomery Street Partners started a $1 billion REIT targeted on investments in the nation’s top 50 markets. High interest from institutional investors prompted Montgomery Street to expand the pool to $1.5 billion in 2022.

Murray McCabe, a managing partner of Montgomery Street Partners, said in a press release, “The strong demand we’ve seen for GLR’s (ground lease REIT) follow-on equity offering validates our strategy and confirms that ground leases have evolved to become an acceptable and mainstream financing tool.”

Clearly, ground lease investment funds are one of the emerging trends in real estate. Ares Management and real estate private equity firm The Regis Group formed Haven Capital in 2020 to capture growing land lease demand to, in their words, provide “a more efficient form of financing” that helps unlock asset value.

These recent developments, along with overall financing trends within the real estate industry, establish a pattern that’s hard to ignore: Land lease activity, which has grown to a more than $18 billion market in 2022, will only see more deals announced over the next 10 years. By one estimate, the market could be close to $2.5 trillion in the United States alone, providing a substantial runway for expansion.

How does a land lease work?

Long a staple of family offices looking for a steady income and predictable stream from long-held vacant parcels in desirable locations, the land lease has become widely embraced because the vehicle presents a win-win scenario for both the building owner and the landowner.

How does a land lease operate? Typically spanning a term of 50 to 99 years with renewal options, a land lease REIT or sponsor acquires the land from the building owner. This arrangement enables the developer to release crucial capital, directing it toward areas with higher return potential. Simultaneously, the building owner retains full control of the asset while divesting the land beneath it, which, though useful in the development process, provides little return to the overall project. The lease is tailored to fit the project.

The Boston Harbor Development serves as an illustration of the long-standing use of land leases in the hospitality industry. Additionally, this approach has found popularity in retail, health and fitness facilities and fast-food outlets. Now, various industries are recognizing the value of this concept. Ground rent payments include predetermined annual lease increases.

“Proof of concept continues to spread,” Safehold’s Doherty said.

As the benefits to a project’s capital stack become readily apparent, ground leases will gain wider acceptance and be regularly employed as a key element in the real estate industry. Predictions suggest that ground leases will become mainstream within the next five to 10 years, offering a spectrum of investment opportunities for astute players.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

To help you understand what is going on in the commercial real estate sector and what we expect to happen in the future, our highly experienced Kiplinger Letter team will keep you abreast of the latest developments and forecasts (Get a free issue of The Kiplinger Letter or subscribe). You'll get all the latest news first by subscribing, but we will publish many (but not all) of the forecasts a few days afterward online. Here’s the latest…

Let’s check in on commercial real estate. This year, 2024, promises to be a mixed year. Sectors like office space are in for more pain, but the picture isn’t so dark elsewhere, and a few segments will thrive. The office market hasn’t seen the worst yet.

Office Space
Vacancy rates are set to go even higher, which is sobering, considering that the national rate just hit an all-time high of 19.6% in the fourth quarter. Look for vacancies to peak at nearly 21% later this year as demand for space stays subdued. 

While more office workers are returning, many continue to work hybrid schedules, a couple of days in the office and a few days at home. So, employers need less space overall, even if their workforces are coming back to the office. Hybrid schedules mean fewer workstations are needed since workers rotate and share common spaces. And, in some metro areas, such as Boston, Houston, Miami, San Francisco and Washington, D.C., the fraction of the remote workforce isn’t falling much. 

So, 2024 will be the year of fire sales on offices. Deep-pocketed private equity funds hold $100 billion to snap up distressed office buildings in big metros like Los Angeles and New York. Meanwhile, office construction and rents figure to both remain stagnant.

Retail Space
Retail space is in for a better year than offices. The surprising resilience of the American consumer supported a big jump in retail construction last year. Building will slow this year, with most new space in suburban shopping centers. Aside from traditional malls, most retail space should hold up, with rents on the rise.

Industrial Space
The formerly hot industrial and logistics sector will cool but won’t freeze up. The burst of demand for warehouses and related space unleashed by the pandemic, when e-commerce surged, is leveling off now. Construction figures to slow notably, as the overall economy downshifts. But rent should still manage 2% growth in 2024.

Data Centers
Demand for data centers should stay hot, exceeding supply and lifting rents. In fact, the rise of artificial intelligence, high-frequency trading and other applications that use massive amounts of data will keep demand for data centers strong for years.

Construction will top 2023’s lofty level, prompting more conflicts with neighborhoods that resent the noise data centers make. Omaha, Nebraska, plus Austin and San Antonio, Texas, figure to be hot markets, given strong local demand and generous tax incentives.

Hotels
It may be a so-so year for hotels as leisure travel softens and hotels face competition from cruise ships and short-term rentals like Airbnb. Urban hotels and airport hotels figure to do the best, with the latter boosted by business travel. Resorts will see another tough year.

Residential
Finally, look for residential space to struggle with slow rent growth. A wave of new apartments hitting the market lately won’t be enough to lower occupancy rates from their high levels but will keep rent increases to a tepid 1.2% average this year.

This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.

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To help you understand what is going on in regards to commercial real estate and what we expect to happen in the future, our highly experienced Kiplinger Letter team will keep you abreast of the latest developments and forecasts (Get a free issue of The Kiplinger Letter or subscribe). You'll get all the latest news first by subscribing, but we will publish many (but not all) of the forecasts a few days afterward online. Here’s the latest…

Delinquent commercial real estate (CRE) loans at U.S. banks are on the rise. The volume of past-due loans in which commercial proprietors missed more than one payment jumped 36% in the third quarter. 

Borrowers have struggled lately to refinance their loans amid declining property values and rising interest rates. Bank lending remains in historically good shape despite the delinquencies. But past-due CRE loans will continue to increase as long as property values remain under pressure, particularly those in the beleaguered office market.

Banks are stepping up efforts to restructure CRE loans to avoid losses. For example, the volume of loans in which Bank of America has either forgiven interest or extended due dates rose by nearly $750 million in the third quarter. Many banks are also setting aside more money to cover expected losses from their CRE portfolios.

The Office Market
The office market is still under pressure as the vacancy rate remains high. The national office vacancy rate reached 19.2% in the third quarter, up from 18.9% in the second quarter. The office market also saw another quarter of relatively stagnant rent growth. Asking rents rose 0.08%, while effective rents climbed just 0.04%. Both have been flat for the past year, with demand for office space still unstable. 

New office construction is on track to finish below the historical average. A key contributor to the problem is that many folks still work from home. Around 26% of households have one person who works from home at least one day of the week, according to recent Census data. But fewer folks are doing so full-time, suggesting that many companies are still shifting toward a hybrid work arrangement.

The good news is that most cities are now seeing workers return to the office. Apart from Boston, Houston, Miami, San Francisco and Washington, D.C., the share of folks working from home has fallen over the last year in all major metro areas.

However, office financing will dry up as demand for office-backed bonds drops. Delinquency rates for commercial mortgage-backed securities focused on office loans rose to 4.6% in October., the highest since 2018, causing many investors to steer clear.

This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.

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Experienced real estate investors are familiar with the ins and outs of the 1031 exchange, a method by which an investment property can be swapped for another (usually larger) one. These transactions need to be carefully structured and are even more complex than a property sale and subsequent purchase, with timelines that need to be closely adhered to and significant regulatory requirements that must be followed.

So why bother?

Let’s take a look at 11 reasons why most professional investors would do well to consider a 1031 exchange.

Reasons 1, 2 and 3: Taxes, taxes, taxes

By far the most compelling reason for most investors to structure their transaction as a 1031 exchange is that it allows them to defer the payment of capital gains taxes on the original sale. An investor who bought a property for $800,000 and is looking to sell it for $1.2 million would be facing a tax bill on the $400,000 capital gain. But by identifying a replacement property and designating the proceeds of the sale of the relinquished property to pay for it, the taxpayer defers payment of the original capital gains tax indefinitely.

A 1031 exchange also allows the deferral of another form of tax: depreciation recapture. When a property is sold, the depreciation that has been taken on the property is generally taxed at 25%. But selling the property as part of a 1031 exchange permits the deferral of this tax as well. Since the depreciation recapture tax rate tends to exceed capital gains tax rates, this benefit can support the benefit of the 1031 exchange further.

Finally, it’s important to realize that the deferrals of these taxes are indefinite and usually within the control of the taxpayer. The taxes do not become payable until the sale of the replacement property. But the investor can control that, either by holding the replacement property indefinitely, or by using a subsequent 1031 exchange to achieve further deferral. There is no limit to the number of 1031 exchanges available to any investor, so in theory, the exchange can be used to defer the payment of taxes for their lifetime.

4. Upsizing your portfolio

Another primary advantage to using a 1031 exchange is that it permits the investor to increase their real estate portfolio without needing to commit additional investment money to do so. The additional equity created by the capital gain in the original property is redeployed in lieu of requiring the investor to provide additional capital for a subsequent purchase. A virtuous cycle of consistently upsizing properties expands the investors' velocity of wealth creation over the long haul.

5. Expanding your portfolio

Similar to a traditional one-for-one upsizing, a 1031 exchange can be used to offload one property for several smaller ones, depending on the investor’s needs. So a large apartment building in a city with a value of $2 million could theoretically be exchanged for three smaller multifamily housing units with an aggregate value of $2 million; the units could be on the same block or in three different cities in three different time zones, affording multiple options to fulfill the investor's needs.

6. Responding to market conditions

A 1031 exchange, or “like-kind” exchange, permits investors to respond to changing market conditions by changing the nature of their holdings. Many real estate investors have done just that in recent years, choosing to forsake the challenges of the commercial real estate market by exchanging office properties for residential real estate holdings, preferring their odds of high occupancy rates in a time when working from home has become increasingly popular.

Other investors have gravitated toward different geographic locations as they see current holdings situated in more challenging scenarios. A 1031 exchange affords investors the flexibility to respond to fluctuating market conditions by altering their investment approach.

7. Using a DST to move away from hands-on management

A Delaware statutory trust, or DST, is a legal entity created as a trust under Delaware law, allowing investors to team with other investors in the ownership of one or more investment properties that are professionally managed. While some investors enjoy the day-to-day management of their portfolio properties, others are content to hand over the management and decision-making responsibilities to a team of professionals.

DSTs can be used to successfully complete a 1031 exchange and address the desire of many real estate investors to reap the rewards of a well-run real estate portfolio without the headaches of actually managing it themselves.

8. Using a DST to achieve (fractional) ownership of otherwise unattainable properties

So you’ve decided to exchange out of your $1 million office building and would like to invest in a luxury apartment building on the Upper West Side of Manhattan. The bad news is that $1 million won’t even buy you a single unit in the building, much less an entire building.

But DSTs can be used to take part in such a transaction anyway, as your $1 million will be combined with other investors’ money, enabling you to have partial ownership of a property that would otherwise be out of reach. Investors often opt for DSTs to access premium real estate opportunities that might otherwise not fit within their financial profile.

9. 1031 exchanges as an estate planning tool

As we mentioned, the ultimate payment of capital gains taxes on the sale of an investment property is almost entirely in the control of the investor, who can usually control whether they choose to sell or, even in the case of a sale, can use 1031 exchanges to further defer taxes. But the ultimate deferral occurs with the death of the investor: Upon death, the investment property in question receives a step-up in cost basis, so that the heirs do not also inherit the previously deferred tax liabilities.

It has been said that the only two certainties in life are death and taxes. However, the 1031 exchange is a process that allows you to defer paying taxes on the sale of certain types of property by reinvesting the proceeds into another property.

10. Using a 1031 exchange on a vacation home or a second home

It used to be relatively commonplace to use a 1031 exchange to swap one vacation home for another, and while Congress tightened the loopholes considerably in 2004, they didn’t eliminate them entirely. It’s still possible to turn a vacation home or a second home into an eligible investment property with the appropriate level of planning, usually by renting it out for a year before exchanging it for another property. Assuming you maintain the proper records documenting the income from tenants during that time, it’s likely that a 1031 exchange would then be permissible.

It’s important to note, however, that simply offering the house for rent without actually renting it to a tenant will not pass muster with the IRS.

11. The ultimate goal: Facilitating the growth of wealth

By deferring capital gains taxes, avoiding depreciation recapture, improving the quality and size of investment portfolios and generally putting more investment dollars to work for them, investors can use 1031 exchanges to dramatically increase the rates at which their wealth increases.

Of course, the IRS doesn’t offer tax breaks without a bevy of conditions, and 1031 exchanges are no exception. I’ve written extensively about the strict timelines that govern the deadlines by which replacement properties must be identified and the exchange must be completed and about the significant terms and conditions involved that require the use of third-party professionals to facilitate 1031 exchanges.

It’s absolutely critical to assemble a knowledgeable, experienced team to assist you with any 1031 exchange and the potentially lucrative benefits of a successful exchange can pay for the costs of the transaction many times over. If you are an investor and wish to gain more knowledge, you can participate in our 1031/DST Masterclasses.

Daniel C. Goodwin, Provident Wealth Advisors and AAG Capital, Inc. are not attorneys and do not provide legal advice. Nothing in this article should be construed as legal or tax advice. An investor would always be advised to seek competent legal and tax counsel for his or her own unique situation and state-specific laws.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Recent proposed congressional changes to investor accreditation laws promise to leave a long-term mark on the commercial real estate landscape.

Previously, only achievable by having a net income of over $1 million or more than $200,000 in annual net earned income during the last two years, the new proposal from the House of Representatives will allow investors to achieve accreditation status by passing a test that proves their “financial savvy.”

The test, which would be administered by FINRA, would be provided free of charge and would assess the individual's competency and knowledge of the private market. It would also address topics like various securities both public and private, corporate governance and risks associated with private assets, like limited liquidity and different disclosure rules.

At the heart of these changes is the aim to democratize investment opportunities to the mainstream by lowering barriers to entry for individuals to invest their capital, thereby potentially altering the dynamics of real estate funding. But what are the realities behind these alterations? Ultimately, this should positively influence the securities space so long as new investors are prudent as they assess real estate offerings if they become more mainstream.

Expanding the investor pool

Currently, accredited investors are qualified with more than $200,000 in earned income per year individually, $300,000 per couple or $1 million in net worth. This approach primarily limits real estate investment opportunities to institutional investors or high-net-worth individuals.

With the relaxation of these criteria, a broader spectrum of investors would be eligible to participate in various real estate ventures, significantly expanding the capital pool available for developers and real estate companies and, in turn, providing investors with an additional source of diversification for their assets.

Boosting crowdfunding platforms

The rise of real estate crowdfunding platforms has been remarkable in the past decade. However, their growth was somewhat stifled by stringent accreditation laws. With eased regulations, these platforms could witness an influx of investors. This would not only provide more investment opportunities but also support smaller, innovative real estate projects that might have been overlooked by larger institutional investors.

More investors means more development in the long term, because it means more capital is making its way into the real estate industry. This would offer investors more project diversification and opportunities to participate in the real estate space.

Enhanced project diversification

With more investors in the mix, developers and real estate entrepreneurs will have the flexibility to explore a variety of projects. They won't be pigeonholed into catering exclusively to the whims and risk appetites of a select few. This means the market and investors may see a broader range of projects, from affordable housing and green buildings to tech-integrated commercial spaces.

For example, at 1031 Crowdfunding, we offer a diverse group of projects in spaces like senior housing, multifamily and medical facilities that provide investors with real estate stratification of investments.

The potential relaxation of investor accreditation laws represents a pivotal moment for the real estate industry. By democratizing access, enhancing the robustness of the investment environment and encouraging a broader range of projects, these changes would herald a new era for real estate development and investment.

As with all reforms, careful oversight and ongoing evaluation will be necessary, but the initial indicators point toward a promising future for the industry.

If you’re interested in learning more about this and other potential legislation affecting real estate securities, check out our website.

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For anyone who is serious about building wealth through passive income, diversifying is key. Owning 20 single-family homes might provide enough rental income to suit your purposes. But if that is the entirety of your portfolio, a single economic event can destroy your income. 

Perhaps you want to expand into apartment buildings or storage unit complexes but don’t have the cash to do so. If that’s the case, consider a real estate syndication. A syndication can grant you access to higher-value assets without you having to carry the entire financial burden. Here is how a syndication can be beneficial and allow you to amplify your passive income.

Basics of a syndication

A syndication isn’t just something that occurs with classic television. With real estate, it’s a way for multiple people to lend financing toward a high-quality asset. Typically, there are two types of participants: sponsors and investors.

The sponsor is the person or entity that organizes a real estate deal and manages the asset afterward. Sponsors are usually expected to invest some capital themselves, but the majority of financing will come from investors. Sponsors receive a management fee for their services. 

If the property becomes profitable, investors will receive the preferred return rate stipulated in their investor deal. So if they invested $100,000 and have a return rate of 8%, they would receive $8,000 per year. Any profit remaining after the sponsor fee and the preferred returns would be distributed based on the contracted split structure.

Rental income

Rentals can provide the sponsor and investors with long-term income. Through a syndication, it’s easier to acquire a multi-unit apartment, retirement community or larger commercial property. Commercial properties are usually more stable earners than residential properties.

There are important considerations before choosing a property to sponsor or invest in for the purposes of rental income. If the property has been in existence for some time, what are its historical returns? Just because a property receives an influx of cash doesn’t mean profitability will necessarily increase. Also, consider the economic trajectory of the area around the property. If large employers have been slowly leaving the area, rental increases over time might not be justifiable.

Property appreciation

Property appreciation is an increase in a property’s value over time. This can be due to ordinary economic growth or actively increasing the asset’s value through renovation. 

Selling a property during a high economic point can be very profitable. Because the timing must be right, it requires keeping a careful eye on economic projections, which usually is a task for the sponsor.

Buying an asset for the purpose of flipping it tends to have a much quicker turnaround. The sponsor will need to find a property, estimate the cost of improvements and renovations and present the plan to investors. 

A benefit of flipping properties rather than keeping them long term as rentals is pricing confidence. An area’s local economy is unlikely to collapse between the time a property is purchased and when it is upgraded and sold. 

Keeping a property long term allows for appreciation over time, but it poses risks of an economic downturn or site damage. While rare, it’s possible a surge of apartments could be put on the market, leaving owners to compete for a limited number of renters. 

A word of caution

Syndication isn’t for everyone. Investors have limited flexibility on the commitment, compared to solo investing, and the ROI could take years. Investors also have limited control — especially since the syndicator/sponsor manages the assets for them. And then there’s the large initial investment that’s required for many syndication deals. 

Higher-value properties with less personal risk 

“Don’t invest with your own money” is an interesting concept. While sponsors are usually expected to contribute some capital, a syndication allows access to real estate tiers that were formerly off-limits to many. With the right management and investors, it can be a powerful way to round out a passive income portfolio.

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The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

The landscape for commercial real estate may look dismal from afar with high interest rates and an office space market still in shakeout mode, but pockets of opportunity remain for investors with the right approach and strategy.

Some — but by no means all — commercial real estate segments (particularly the office market) bore the brunt of the post-COVID upheaval. Even prime properties have seen ratings downgrades. Community and regional banks have been reluctant to enter the space as bank regulators and rating agencies keep a keen eye on exposure to deals on shaky footing.

But in spite of those developments, there are categories that look attractive for investors, including the retail, industrial and hotel sectors.

Major fund sponsors are creating new vehicles for investment. Sellers are accepting deals they wouldn’t have considered a year or even six months ago. The seemingly unyielding rise in interest rates may be coming to an end, considering Fed officials’ recent comments.

“Hot” markets such as Austin and Phoenix are still relatively highly valued and probably best avoided. But potential returns are inviting in some smaller markets like San Antonio, Albuquerque, Birmingham and Tulsa.

Some long-term opportunities

There are some good long-term opportunities, too, in the Northeast and Midwest. Milwaukee and Detroit have stabilized. Minneapolis has a stable of Fortune 500 companies, a strong university presence and a great recreational market, making it an interesting prospect. Indianapolis is among the Rust Belt communities seeing growth with what appears to be a resilient economy that is home to several companies with staying power.

Boston, Philadelphia and Atlanta have diverse business bases, as does Washington, D.C., which is also getting Amazon’s HQ2 and has the federal government ordering workers back to the office. Newark, N.J., still gets a lot of bad press, but the logistics and industrial market there is second to none.

Still, there aren’t shiny deals under every rock. Lenders won’t touch San Francisco, for example. The city has lost a material portion of its talent base, and the appeal of its natural beauty has waned in view of other detractions. It’s going to take a lot to bring the city back.

Financing and interest rates are a hurdle

More broadly, despite the opportunities and the easing of rising interest rates, financing remains a hurdle. When debt isn’t available, a potential buyer needs to find a seller that’s willing to carry the mortgage while the property is leased, renovated or otherwise set up to make money. It’s going to take creative financing to make the market come back to full health.

A buyer who is fiscally prudent on the management side — that means not spending money on amenities that have no value to a tenant — and a reasonable medium- to long-term view on real estate will be able to find deals that generate positive cash flow, even before tax benefits.

There remains a great deal of uncertainty and turbulence in the commercial real estate sector. As the bottom fell out of the office market, rates were changing so fast people couldn’t figure out what buildings were worth.

But by this time next year, it should be clear that cap rates and yields have peaked. Property values are very likely to rise, and many investors will wish they had been more aggressive. Those who did buy will be able to refinance and see respectable returns.

Be aware, too, there are new complexities. Artificial intelligence, for example, will be a game changer for real estate just as it will be in other industries. Not only will the way properties are analyzed and managed changed — the tenants and users of buildings are likely to be changed by AI, too.

What will become of the office market?

As for the current ugly duckling: The office market will at some future point come back. Many people are finding it’s not as easy to work from home now that not everyone is doing it. Companies and bosses are fully cognizant that innovation and productivity were higher with workers gathering in proximity to one another. While versions of remote work will persist, there’s now a clear trend back to a more traditional direction.

The pandemic created a wildly distorted market, and investors are always spooked by market distortions. Some commercial real estate sectors have taken the brunt of that impact, but commercial real estate overall will continue to be a stable asset class.

And any investor who’s not searching for cash flow-positive deals is likely to regret it next year.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

The commercial real estate market continues to struggle, despite the housing market preparing for a rebound. To help you understand what is going on and what we expect to happen in the future, our highly-experienced Kiplinger Letter team will keep you abreast of the latest developments and forecasts (Get a free issue of The Kiplinger Letter or subscribe). You'll get all the latest news first by subscribing, but we will publish many (but not all) of the forecasts a few days afterward online. Here’s the latest...

Expect the inventory of existing homes on the market to remain low. Supply has ticked up over the past year but remains historically thin. And no wonder: About 60% of outstanding mortgages have a rate of less than 4%. This makes many homeowners reluctant to sell and give up their low interest rates. 

Not surprisingly, new listings have continued to fall over the past few months as rates hover near 7%. Though home prices are down a bit from their peak last year, they’re still high by historical standards and have started to perk up. 

Sales of existing homes have further to fall, after dropping by 3.3% in June from May, and 19% from a year ago. More drops are likely this summer. But sales should gradually turn up by the end of 2023. 

Mortgage rates will likely fall below 6% by year-end, driven by a drop in the 10-year Treasury yield and declining spreads between Treasuries and what lenders charge on home loans. That should lead to slightly better affordability for buyers and a pickup in selling.

The office market remains under pressure, as much space goes begging amid the continuing work-from-home trend. The national office vacancy rate reached 18.9% in the second quarter. On the construction front, the total growth in office space inventory in the first half of 2023 stayed well below the historical average. 

Vacancy rates have even further to rise as remote work remains popular. American workers on average are coming into the office only half as frequently as in 2019. Metro areas with lots of tech companies will continue to feel pressure, given their high rates of remote work. Asking and effective rents haven’t changed much over the past four quarters as demand for office space has remained volatile. 

Financing for offices is drying up. Delinquency rates for securities backed by commercial mortgages on offices rose to 4.5% in June — the highest level since 2018. The rise in delinquencies is leading some investors to stay away from commercial mortgage-backed securities with too much exposure to offices.

This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.

Deciding how to invest in real estate can sometimes seem complex and overwhelming, especially when you don’t know what’s hot and what’s not. So we at Kiplinger.com asked some of the financial experts among our Building Wealth contributors and Kiplinger Advisor Collective members to answer, in a few sentences, this question:

What is one current trend in real estate investing, and how can investors take advantage of it?

Their responses range from checking out online real estate investing platforms, to exploring tax-advantaged qualified opportunity zones, to keeping an eye on the debt issues of commercial real estate. Or maybe you might be interested in owning some rental property that you can also use as a vacation home. Wherever your real estate interests may lie, there’s bound to be a tip here that could snag your interest.

Perhaps you’ll even be inspired to check out some of the stellar financial advice these experts offer Kiplinger.com readers on a regular basis (just click on their name to see their contributions and learn more about them).

Here’s what our experts had to say…

Online platforms can forge connections
“One current trend is using online real estate platforms. The advantage of using online real estate platforms is helping investors get involved in bigger commercial deals without having to put down thousands or even millions of dollars. It is a very lucrative avenue due to the fact that a novice investor does not have the connections or the relationships to be introduced to opportunities in order to invest in that type of real estate. And so, online platforms now are giving more exposure to the individual investor. Whether you are a savvy investor or just getting started, online platforms have numerous starting points for all investors.” — Edward E. Fernandez, a Building Wealth contributor

Look for areas of business growth
“Identify areas where growth in business is starting to happen, because more business brings more people — and a greater need for real estate. It’s also important to remember not to limit this to your home city or state. You can take advantage of it by buying real estate while the cost and interest is lower. Over time, its value will increase, and then you can consider selling at the right time.” — Angela Ruth, a Kiplinger Advisor Collective member

QOZs for the tax-advantaged win
“Real estate investments in qualified opportunity zones (QOZs) have reached record highs as billions of dollars of private investors’ capital have been invested over the past five years into QOZ funds. Many consider QOZs to be one of the best pieces of tax legislation in a generation to combine tax benefits with some very attractive real estate development projects around the USA. QOZs accept funds resulting from any capital gain (long or short term), and the gains can come from the sale of real estate assets, appreciated stocks, crypto, closely held businesses or any other form of capital gain. QOZs typically invest in Class A multifamily apartments, self-storage, medical, industrial and life science facilities. Capital gains tax can be deferred until 2027 for most taxpayers, and if the QOZ investments are held for 10 years, then 100% of the gains can be tax-free to the QOZ investor.” — Daniel Goodwin, a Building Wealth contributor

Consider passive real estate investing
“If your only idea of real estate investing is owning a property that requires regular upkeep and attention, you’re missing a big opportunity. Passive real estate investing is becoming more popular and offers the potential to make a return without actively managing a property. Through crowdfunding, you can invest in real estate projects that help diversify your overall portfolio.” — Tore Steen, a Kiplinger Advisor Collective member

Opportunities in real estate debt
“With the Fed pushing rates higher for longer, it has eliminated the majority of investment strategies that have worked over the past 15 years. Our view is that the opportunities now and in the next few years will be in real estate debt rather than direct equity investments or development projects. There are fantastic funds in the debt space that can capitalize on this generational opportunity, and it brings substantially less risk than direct real estate investing — just be sure to do your diligence ahead of any such investment.” — Tory Reiss, a Building Wealth contributor

A community of like-minded folks could help
“Find a community of like-minded people you have an authentic fit with to learn from, build relationships with and have an opportunity to be presented real estate opportunities through. If you can dream it, there is most likely a way for you to get into real estate investing. The better questions are: Where are you going? What vehicle would be best suited for you? And what is your timeline?” — Lyndsey Monahan, a Kiplinger Advisor Collective member

‘Industrial is better than ever’
“Investment properties still provide attractive risk-adjusted returns in investors’ portfolios. This is particularly true for investors/advisers seeking tax alpha (returns on an after-tax basis). If investors are relying on plentiful, cheap mortgages to create positive leveraged returns near term — that strategy is dead for a while. In addition, flipping (buy low/get lucky) is also played out for a while. Those buying solid real estate (good location, good tenants), leveraging the property modestly (i.e., investing real equity) so it pays the mortgage and provides stable cash flows have many opportunities in today’s market. The problem is this strategy takes real equity and time. Painting all ‘real estate’ with the same brush is foolish — office properties are in trouble; retail is a tale of haves and have-nots — so be careful. Industrial is better than ever. The demographics and lack of new supply represent strong fundamentals that can’t be stopped (even with higher interest rates).” — David Wieland, a Building Wealth contributor

‘Any property’s value has the potential to flourish’
“Find the cost-efficient deals when making the initial investments and work toward creating a passive income by adding value to the properties. Though this seems like a no-brainer, the key idea is to remember that the initial investment doesn’t have to be costly to have a good ROI. At the end of the day, any property’s value has the potential to flourish if you allocate your investments wisely.” — Justin Donald, a Kiplinger Advisor Collective member

‘Syndication offers the best of both worlds’
“If you have the money, syndication offers the best of both worlds: direct ownership in a specific existing property or ground-up development managed by seasoned professionals. It's cleaner (and less stressful) than piecing together a rental portfolio on your own and more profitable than REITs or crowdfunding. The catch is that the minimum investment is usually $25,000 to $50,000, sometimes more.” — Andrew Schrage, a Kiplinger Advisor Collective member

Discount commercial properties may be coming
“One of the main trends we are seeing, especially in the commercial real estate market, is the rapid increase in delinquency rates of commercial mortgage-backed securities (CMBS) backed by office properties. This is already causing significant waves throughout the commercial real estate industry, including forcing many owners of commercial properties to give back their properties to lenders because they can’t maintain the debt service. There are many reasons behind this trend, but the biggest takeaways that I see for investors is that in the coming couple of years, there is the likelihood that commercial properties will be able to be acquired at a discount, especially if they are purchased without leverage or on a debt-free basis.” — Dwight Kay, a Building Wealth contributor

Rental property that’s a second home
“Most people think of real estate investing as rental homes near their current residence. Think beyond where you currently live and consider destination spots that include beaches, mountains, lakes and other up-and-coming areas. If short-term rentals are allowed, consider the dual purpose of rental income during the peak season and then use it yourself as a second home in the off-season.” — John Bodrozic, a Kiplinger Advisor Collective member

Kiplinger Advisor Collective is the premier criteria-based professional organization for personal finance advisers, managers and executives.

I never recommend an investment solely for the tax benefits. It must be a good investment and be suitable for the client. If an investment makes sense as part of a diversified portfolio and can provide tax benefits, then it is a win-win.

Real estate is one example. Investors can own real estate in their investment portfolio through a REIT, or a real estate investment trust. REITs can own apartment buildings, student housing, warehouses, data centers, medical buildings, office buildings and other types of real estate.

Like any investment, REITs have their pros and cons. REITs can provide diversification — for example, from 2000-2020, REITs helped improved the performance and diversification of stock-bond portfolios, according to one study by TIAA-CREF. REITs can act as an inflation hedge to protect savings — real estate owners can increase rents. REITs can also have a high distribution yield.

However, REITs are not without risk. They can lose value. But it’s the tax advantages of real estate investment trusts that I want to focus on here. The following is adapted from our upcoming webinar on tax-smart investing.

Return of capital and REITs

A REIT’s dividend or distribution income is ordinary income if held in a taxable account like an ordinary brokerage account (non-IRAs and non-401(k)s). However, REITs can take advantage of tax deductions for depreciation and amortization — a portion of a REIT’s distribution can be classified as a return of capital (ROC), which reduces the amount of the distribution that is considered taxable.

JP Morgan Asset Management found ROC distributions may reduce the taxable portion of REIT distributions by an estimated 60% to 90%, allowing for more of the dividend to be income-tax-free. Figure 1 above compares a taxable corporate bond distribution, which is 100% ordinary income, to that of a REIT with a 90% ROC. Here, the ROC significantly lowers the taxable portion of the distribution.

The downside to ROC is it reduces your cost-basis (the purchase price of the asset). This can trigger a larger capital gain when and if you sell the REIT later. A solution can be employing an aggressive tax-loss harvesting strategy with other money in your portfolio, booking the losses and using the losses to offset the capital gain from selling the REIT. The IRS allows you to offset long-term capital gains with long-term capital losses. Unused losses in the current year can be carried forward indefinitely on your federal tax return (state rules vary). Return of capital is an important tax advantage for REIT investors.

TCJA REIT rate reduction sunsets at the end of 2025

Another tax advantage of REITs was ushered in by the Tax Cuts and Jobs Act of 2017 (TCJA), the REIT rate deduction. TCJA offers a 20% deduction on qualified income for certain non-corporate taxpayers and captive REIT dividend income. For example, under the TCJA, the new maximum individual effective tax rate of 37% coupled with the 20% deduction equates to a 29.6% effective tax rate on ordinary REIT dividends as compared to 39.6% under prior law. (It’s important to note that the 20% rate deduction to individual tax rates on the ordinary income portion of REIT distributions is set to expire on Dec. 31, 2025.) Figure 2 illustrates the potential benefit the 20% rate reduction has on varying tax rates.

Putting it all together

For my clients, I may recommend anywhere from 5% to 15% in real estate investments, though it depends on each investor. As I mentioned earlier, I like REITs for their diversification — it’s another, different asset class to balance a stock and bond portfolio.

I also like the dividend income, which can get reinvested and help the investment compound over time. Finally, the tax advantages help, too. Figure 3 illustrates how the ROC and TCJA rate reduction for REITs can help improve the after-tax or tax-free distribution.

Some may question, why own the REIT in a taxable account? Why not put REITs in an IRA or 401(k) to avoid current taxation all together? That is a plausible idea and can make sense. However, distributions from IRAs and 401(k)s are 100% taxable as ordinary income. A REIT in a Roth IRA can make sense since qualified distributions are income-tax free. However, if you don’t have a Roth IRA or enough money saved in Roth accounts, owning REITs in taxable accounts may allow you to take advantage of the return of capital and TCJA rate reductions, which can significantly reduce the taxes on distributions.

Taxes aren’t the only consideration, but they’re not something to overlook either. There are many types of REITs and different types of ownership, such as publicly traded REITs vs. non-traded REITs. It’s important to work with a professional who can help you navigate the choices.

For more information consider our upcoming webinar on Tax-Smart Investing.

Michael Aloi is a Certified Financial Planner with 22 years of experience. For more information or a complimentary review of your pension options, please feel free to send him an email at maloi@sfr1.com.

Investment advisory and financial planning services are offered through Summit Financial LLC, a SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Summit is not responsible for hyperlinks and any external referenced information found in this article.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Commercial real estate investing could be an option for adding alternative assets and balance to your retirement portfolio. Let’s explore why.

The current financial landscape may have individuals confused as to what’s next for their investments. Stock market volatility, climbing interest rates, stubborn inflation rates that keep persisting and a maxed-out debt ceiling — it’s enough to worry any investor.

But for those investors approaching retirement, this uncertainty can be compounded as they head into a period where they attempt to rely on the wealth they’ve accumulated for decades.

As an investor shifts from wealth accumulation to wealth distribution, what are the questions he or she should be asking when they evaluate their retirement portfolio?

The traditional 60/40 portfolio of stocks and bonds may not be the ideal investment mix for someone looking to manage risk with their investments. That’s why I’ve been a longtime advocate for creating a diversified portfolio that follows the tenets of Modern Portfolio Theory, or MPT.

Commercial Real Estate Investing Helps With Diversification

MPT is an investment strategy that allows investors to use diversification to manage portfolio risk while seeking increased returns. Using the principles of MPT, an investor’s portfolio contains stocks, bonds and alternatives such as real estate to create a more sophisticated mix of different investment classes. With a more diversified portfolio, the higher the level of risk you’re willing to take, the higher the potential you can receive better returns.

At Realized, we believe a balanced portfolio that contains alternative assets can help investors improve returns while managing risk. However, only 15% of workers have real estate included in their retirement portfolios.

Let’s explore why real estate, specifically commercial real estate, could be an option for an alternative asset in your retirement portfolio.

Why Alternative Assets?

Alternative assets, such as real estate, hedge funds and NFTs, were previously only of interest to institutional and high-net-worth (HNW) individuals. While they have become more mainstream in recent years, they can be considered somewhat riskier as they don’t have a very long track record and may not be as regulated (see the recent woes of the cryptocurrency market).

MPT principles suggest diversified portfolios should contain between 10% and 20% of alternative assets, but most individuals are falling short of that threshold. Institutional investors such as pension funds and endowments, typically have 30% to 50% invested in alternative assets, whereas most individual investors have only 5% of their portfolio dedicated to alternatives such as hedge funds, private equity and real estate.

Why Have Real Estate in Your Retirement Portfolio?

According to data from Griffin Capital, the average return in a portfolio of 60/40 stocks and bonds is around 6.86%, while a portfolio that has 55/35/10 of stocks/bonds/real estate has slightly higher average returns of 7.06%. An additional potential benefit of adding real estate to a portfolio is the volatility between the two portfolios decreased from 9.90% to 9.15%, respectively.

Many of our clients have used direct real estate as a way to diversify their portfolios and accumulate wealth over the years. However, the hassle of managing tenants and the risk of geographic concentration are factors to take into consideration when evaluating retirement goals and planning.

For investors who want to keep real estate in their portfolio without the daily responsibilities, transitioning into passive real estate ownership may be an option for them. By executing a 1031 exchange when they decide to sell their direct real estate, an investor can defer the capital gains taxes and invest their proceeds into another “like-kind” investment property, keeping more of their wealth working for them.

The like-kind property can either be another direct investment property or fractional ownership of a commercial property. Commercial real estate can be an option for investors who want the potential long-term benefits of investing in real estate without the hassle associated with tenant management.

Investors have the ability to invest in commercial properties such as industrial facilities or multifamily properties by using investment vehicles like REITs (real estate investment trusts) or Delaware Statutory Trusts (DSTs). These investments are professionally managed commercial real estate properties that pool real estate and financial resources from a group of investors. The investors receive the benefit of passive real estate ownership without the work of direct property management.

Let’s take a closer look at both of these options.

Delaware Statutory Trusts. DSTs give investors access to fractional ownership of commercial real estate properties like apartment complexes, retail centers and industrial facilities. They are established by sponsors who secure the funding, find a property management company and manage the day-to-day operations and decisions associated with the property.

Accredited investors are able to invest as little as $100,000 into a DST, and they can purchase fractional interests in these properties even if they do not live close to the property. Additionally, any debt acquired in creating the DST is held by the trust and not the individual investors.

With high inflation levels throughout most of 2022, investment property owners also likely saw the increase in operating costs cutting into their net profits if they owned traditional rental properties. With a DST, that financial obligation falls to the sponsor instead of the investor directly, which can help investors pursue a steady income stream throughout the investment’s holding period – a consideration for investors who are in the income-harvesting mindset instead of income-generating mindset.

Additionally, certain types of commercial real estate, such as apartment complexes, student housing and hotels, offer more potential for rate increases and adjustments than direct properties. The volume of tenants each building can hold, the number of lease renewals for apartment buildings and the daily rate updates possible with hotels provide owners with more opportunities to keep pace with market fluctuations.

REITs. A REIT is a company that owns, invests or finances real estate or real estate-related assets. REITs give investors the ability to invest into a larger portfolio of real estate, similar to how investors are able to invest in stocks. Similar to DSTs, they also offer passive investment, as the REIT’s underlying real estate is professionally managed by a third party and not the investor. There are several different structures of REITs, as well as different kinds of investments within the REITs themselves. The two most well-known forms of REITs are public REITs and private REITs.

Public REITs are registered with the SEC, and their shares are listed and priced on a national securities exchange. Shareholders can sell REIT shares at market price whenever they would like, but they are subject to a taxable event. There is no minimum investment amount to invest in a public REIT, and all management and operations decisions are made by the trust.

Private REITs are available only to institutional or accredited investors. Shares are not traded on public exchanges. Share redemption programs vary by company and may be limited or only allowed within a specified period of time. Private REITs usually have a higher minimum investment threshold of $1,000 to $25,000, as they are designed for accredited or institutional investors.

Whether an investor is building their retirement portfolio or assessing their investments before entering into retirement, there are opportunities and options available to them within commercial real estate. Consult with a financial or tax professional to learn more about the types of investments that best suit an individual’s income needs, risk appetite and investment objectives.

Full disclosure. The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Stocks continue to swing wildly as inflation remains at 40-year highs. And as interest rates start to rise to rein in that inflation, bond prices have fallen.

Times like this clearly show the value of diversifying a portfolio beyond stocks and bonds. Real estate is one way to do that because this asset class generally doesn’t move in tandem with stock and bond markets.

Real estate also has another huge advantage: It’s a hedge against inflation. Properties can raise rents to adjust for rising prices. Plus, property values tend to increase along with inflation.

How today’s savers can invest in real estate

For individuals, the opportunity to invest in real estate, particularly commercial real estate, has traditionally been limited because of the huge financial commitment that’s required. Only the wealthiest, for instance, could afford to invest in commercial real estate by acquiring, say, warehouses or office buildings.

As an alternative, smaller investors have turned to buying one or two houses to rent out. Although that, too, can take sizable capital and time, especially if they manage the rentals themselves.

But now CRE Income Fund offers a new option for accredited investors: the CRE Diversified Income Fund.

This private real estate fund was launched in 2020 to buy and manage high-quality commercial real estate in growing markets across the country. The fund is designed to provide investors with a reliable income stream as well as potential capital gains through the appreciation of the properties.

• See also “4 key reasons to invest in commercial property vs. residential.”

Predictable income, plus the potential for capital gains

A key challenge for many investors is finding truly passive investments that generate predictable and substantial income. So, a big benefit of investing in real estate through CRE Income Fund is that it pays investors a stable monthly income – 10% annual yield – from a portion of the rents collected.

What’s more, investors don’t have to scout out properties, tie up their money buying them, find tenants, then manage and maintain the buildings. The fund’s real estate professionals, who have experience buying and operating high-return investment properties, handle all the “active” work for you.

Over time, the underlying asset could also increase in value. And that can result in the opportunity to sell and realize a capital gain.

Other benefits of the CRE Diversified Income Fund include:

• Sector and geographic diversification: The fund not only acquires different types of commercial real estate, but it also selects properties across the country.
• Tax efficiency: Investors are able to reduce taxable income on a part of their distributions through the use of depreciation.
• Limited liability: Investors have no liability beyond their investment.
• See how CRE Income Fund helps mitigate inflation risk for investors. Hint: One key strategy is written into every lease.

Why commercial real estate?

The pandemic and subsequent national lockdowns will likely have a lasting impact on commercial real estate and the demand for space.

Online shopping exploded during the first two years of the pandemic and shows no sign of letting up. Supply chain disruptions also are encouraging U.S. manufacturers to bring their offshore production back to the states. Wholesalers and other companies will want more storage space so they can control inventory and avoid supply interruptions. And there’s been an increase of investment in medical research, from COVID-19 vaccines to other therapeutic breakthroughs.

CRE Income Fund has identified four sectors that are well-positioned to benefit from these trends:

• Supply chain distribution
• Research and development
• Cold storage
• Logistics

With these targets in mind, the CRE Diversified Income Fund’s investments include several warehouse/distribution, cold storage and research & development facilities around the country.

• See CRE Income Fund’s current properties.

The fund’s strategy

The CRE Diversified Income Fund targets properties in markets with high rental growth, low vacancies, a growing population and the potential for real estate appreciation. Each acquisition is made with an exit plan in place, with an anticipated holding period of several years.

The fund reduces its risk by only leasing to investment-grade tenants. A portion of the rents collected are paid out to investors. The fund pays an annual 10% dividend yield with a targeted 12% to 14% annual return.

• Got questions? Request a confidential CRE Investment Summary.

What to know before you invest

The private real estate fund is open only to accredited investors, which include certain investment professionals and those with a higher level of income or net worth. The minimum investment is $10,000, a level that makes commercial real estate accessible to more investors.

The fund is not publicly traded on any exchange and may hold properties for several years before selling them. Investors should consider this a long-term investment, although they have an opportunity to redeem shares on a semi-annual basis.

The bottom line is that investors are always looking for smart ways to diversify their portfolios. In today’s environment, however, finding ways to hedge against both inflation and market volatility is vital, too. For some individuals, investing in commercial real estate may be the answer. And these investors could benefit from checking out the CRE Income Fund.

See how easy it is to begin investing in commercial real estate with CRE Income Fund.

This content was provided by CRE Income Fund. Kiplinger is not affiliated with and does not endorse the company or products mentioned above.

There are many questions circulating within the commercial real estate investment landscape as the COVID-19 crisis unfolds. Will the market return to normal soon? When will rents be collected? Am I going to lose my investment?

I’ve gathered some of the most common questions I’ve been asked and have provided answers that will help guide you through the next 90 days.

If I have money tied up in real estate investments, can I tap into the equity to pay bills and my mortgage?

It depends. If you have buildings that have not been critically impacted or if you have properties that are low leveraged, you may be able to tap some of that equity. The challenge now is that the lending market for borrowers is uncertain. There’s money available, but the terms can be prohibitive. For example, some lenders are requiring additional reserves to cover six to 12 months of mortgage payments. Other lenders are prohibiting cash-out loans. For some owners, a line of credit may be the best option.

Additionally, your available equity is predicated on the property’s cash flow and debt coverage, so money may not be as readily available as it had been in the past. Here’s why: If you own commercial real estate, you likely also have tenants, whether they're commercial or residential. The majority of U.S. states have shelter in place orders and/or social distancing restrictions, which may not be lifted until the end of May or early June. Many commercial tenants cannot open their doors because of these orders and may not be able to pay their rent. Residential tenants are profoundly impacted as can be seen by the climbing unemployment figures. The CARES Act as of now provides for enhanced unemployment and a one-time stimulus check, but there is no requirement that the tenants use the funds to pay rent.

Given this uncertainty for collections, I would say that tapping into your investment is going to be more difficult today than it would have been even two months ago.

Should I hold off on new investments, then?

At present, we’re seeing transactions that were already near the finish line closing. Most other real estate transactions are being put on hold, or the closing is being extended by 90-120 days. Collections are a big unknown for many properties right now. Collections and net operating income set the value of the real estate, but just as important, sets the size of your loan.

We’re also seeing across the market, no matter the property type — multifamily, office or retail — there’s a moment of pause right now. As an example, a multifamily acquisition transaction cycle normally takes two months from start to finish. We’re seeing these same types of transactions now pushing their due diligence out to a 90-day period, with 60 days to close after that (five months). If buyers and sellers are willing to cooperate and take current conditions into consideration, deals will get done. They're just going to be a little different than it would have looked like two months ago.

There may be options for opportunistic investing in 2020, depending on how long COVID-19 disrupts the economy. Good buying opportunities could include properties approaching the end of their financing term or those with troubled operations. Loan maturities are “drop dead” dates that force owners to either sell or refinance. Refinance options have become a lot less attractive in this lending environment, which may prompt sellers to just take a discount on sale instead of taking a loan with low leverage and large reserve requirements.

The same goes for owners who are over their heads with failing operations. When property cash reserves and owners’ own resources are unable to float a property through lean times, then owners may choose the better of two difficult options and sell at a discounted price to avoid foreclosure.

Why is asset management such a hot topic right now?

One reason that investors go into sponsored real estate investments is because the sponsor also oversees asset management on their behalf. It’s a passive investing strategy for those who want the benefits of commercial real estate investment, without the hassles of being a landlord.

Asset management is that layer of oversight between the property’s daily operations (property management), and the owner or investor. And now more than ever, asset managers are scrutinizing property operations with the goal of balancing the needs of the property with the goals of the investors.

An experienced asset manager can navigate an investment property through shocks to the real estate cycle. In the event of a pandemic, natural disaster or any other threat to the property, they are prepared to operate in a very conservative mode to protect the investment. Good asset managers also keep an open dialogue to communicate with owners and investors in real time. Examples of communicating effectively could be sending updates on instituting new procedures to protect the health of residents and staff, changes to business plans, or outlining new rent-collection policies.

The impact of COVID-19 is shaping up as a defining moment for real estate asset managers. Some of the weaker asset management teams and sponsors have “gone dark” leaving their investors wondering if rents are being collected or if mortgage payments are being made. The ability to quickly reprioritize the business plan (e.g., stop capital projects to reserve cash) also distinguishes strong, proactive asset managers from more passive counterparts.

Economic fallout of COVID-19 introduces a real possibility of foreclosure for some properties, and inexperienced asset managers may be unprepared for such a challenging scenario.

So, what’s a ‘sponsored investment’?

The term “sponsor” is used to describe the individual or company responsible for sourcing, purchasing and managing a real estate investment — from acquisition through the eventual sale.

First, a real estate sponsor pools together a group of accredited investors and acquires a property. Then, the sponsor continues its investment oversight as an asset manager, overseeing the business plan, driving value and eventually directing the property’s sale.

Typically, investors receive monthly or quarterly distributions throughout the ownership period. In the case of a crisis, such as COVID-19, distributions might be suspended for a period of time in order to build cash reserves. Investors understand that real estate is a long-term investment strategy and will eventually receive funds.

Should I look at real estate over other traditional investment types?

At the end of the day, real estate is a long-term game, with a long-term horizon. When we talk to investors interested in sponsored real estate, we tell them the same thing. Right now is no different, and we're reminding them of this exact same game plan.

Yes, the next six months are uncertain. Real estate and lending markets are not stable at the moment. But, again, commercial real estate investing is about the long term. We know that rents will get paid — perhaps temporarily with payment plans — and property incomes will stabilize. We know we will go back to a normalized model.

When we have that data that rent collections are going in the right direction and the debt markets begin to normalize, my recommendation is this: Move quickly.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.