Our guest expert for this post is Darcy White of Westred Partners Inc. You can learn more about him at the end of this post.
Robert Kiyosaki, in his 44 million copy selling book on personal finance, Rich Dad, Poor Dad: What the Rich Teach their Children about Money that the Middle Class and Poor do Not! (1997) offered, as a teaching metaphor, a comparison between his highly educated and successful father (Poor Dad) and his less educated entrepreneurial best friend’s dad (Rich Dad). His own father, a high earning professional, suffered by comparison to the low wage, entrepreneurial dad who is revealed to eventually own a portfolio of high equity commercial real estate.
I have lived Kiyosaki’s metaphor. My father was an electrical contractor who built sawmills and dry kilns all over Western Canada. He was a capable, honest, and respected tradesman, and I am proud to be his son and carry his name. My father-in-law was a real estate developer, landlord and investor. And, while I owe much of what I have to both of these two men, I am not an electrical contractor. I own and manage a real estate investment company that I have named after my father-in-law.
Over the past 22 years I have created, financed, and led three different investment companies focused upon identifying distressed commercial real estate (CRE) properties with unrealized, or latent value. I have purchased, renovated, re-financed, and eventually realized a favorable return on investment in them.
CRE encompasses residential housing, warehousing, retail, and office spaces, and each has a risk profile that is influenced the quality of the building and lands, security of tenancies, prevailing capitalization rates, interest rates, and always “location, location, location.”
Risk vs Reward
When my partners and I undertake a commercial real estate project, we believe that we are engaging in a predictable, projectable, and a low-risk enterprise. Commercial real estate (CRE) has its specific and endemic risks, however, as an asset class it can be purchased with leverage, appreciates faster than the inflation rate, has relatively weak management competition, and is operationally uncomplicated.
Returns on Investment
Returns in real estate are taxed or tax-deferred, and, depending upon your investment goals, can be timed for tax efficiency. Payment of mortgage principal are taxable. So are the incomes after allowable expenses. However, asset appreciation in the market, which can be substantial is deferred and can be timed through refinance or sale of the asset.
A good manager might be able to realize double-digit annual returns in the range of 4% capital repayment, 4% free cash from operations and 4% market appreciation. However, paying down principal, refinancing, raising rents, and improving operational efficiencies can improve those returns every year.
Limitations of Commercial Real Estate Investing
While there are varied ways to participate in a CRE investment, usually the bar for investing, outside of a registered fund, is high. To be clear, CRE is not usually the way to make a quick buck. All investments are measured “over time,” and real estate is no different. Good commercial real estate investing is a patient process and may not be for all investors.
Recommendations for Investing in Commercial Real Estate
I am not an evangelist; however, I do urge those involved in high income, low asset value businesses to consider adding well-chosen, investment class real estate to their financial portfolio. Participating in CRE can be as simple as renting a (legal) suite in your home, owning your business’ facility, participating in RRSPs that include real estate, or partnering in a syndicated real estate partnership. I have participated in all the above, and in the right circumstances, I regard each as a reasonable approach to building wealth.
However, like all financial decisions, I would counsel engaging industry professionals: financial planners, accountants, and legal counsellors in the process. There are no shortcuts to executing a good financial plan, and the cost of fixing one is high. As an aside I must acknowledge that my progress and results are evaluated, accounted for, and reported on for taxation, right here at Avisar.
If I were to advise my hardworking father in 1982, I would have insisted that he invest some of the earnings from his best years into commercial real estate. When he retired in 1996 and laid down his tools, his earnings ceased with the collection of his last outstanding account. By comparison, when my asset-rich father-in-law retired in 1996, his net worth increased in value more than 150% over the next decade while his earnings continued to rise. Moreover, he was able to exercise provisions in the Canadian Tax Act to optimize his CPP, OAS, wage, shareholder provisions, and a host of other rights available to him (See your professional accountants at Avisar for more on this 😊).
I need to come clean. I did not research and discover real estate – I was neither that prescient nor clever. Rather, real estate found me. My father-in-law invited me to join him and manage his real estate assets. However, I was a willing student and quickly discovered that I loved what I do working in real estate.
I love my work.
Finally, to be clear, both of my fathers were rich in the ways that truly mattered. Both were beloved spouses, good parents, and doting grandfathers. They were dear friends to many, supporters of numerous charities, community builders, and good men. These were truly great men, and their legacy extends beyond their net worth.
For the record, I also recommend carry-on luggage, paying for tour guides in museums, purchasing good shoes, always stopping on road trips for go-carts and ice cream, buying as good a wine as the occasion demands, tipping, and splitting the entre.
I podcast weekly at: https://soundcloud.com/advanced-rei
I write on real estate, leadership, and dadding at: www.darcywhite.ca
And I can be reached at: email@example.com Cheers to meaningful work, community building, and making a difference!
Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.