The continued threat of a national recession coupled with persistent high interest rates may pose some serious challenges to the commercial real estate industry in 2023. Despite this cloud of uncertainty, real estate still remains at the forefront of investor interest with investors pouring a record amount of capital into commercial real estate over the past two years.
These issues also may be why portfolio diversification and rebalancing are being embraced by high net worth individuals, accredited investors and wealth managers seeking alternative revenue streams that aren't directly tied to public equities markets. Investors poured $717 billion into commercial real estate investments last year, a record exceeded only by the $835 billion invested in 2021, CBRE reported in its 2023
By way of comparison, just $80 billion of capital was invested in commercial real estate in 2009 when much of the country was still trying to shake off the effects of the financial crisis, the commercial real estate and investment services firm reported.
As we continue to navigate financial uncertainty, I predict we will see more wealth managers and their clients add fractional ownership in commercial real estate to portfolios as a means to seek passive returns with more potentially steady income.
These investments can be high risk, so they are not suitable for every investor. However, those that do find it appropriate can park these passive commercial real estate investments alongside more traditional wealth-building and retirement instruments such as 401(k)s and IRAs or other equity investment portfolios.
Even if the country does experience a full-scale recession this year, it's not expected to hit as hard as past recessions, CBRE reports. The higher cost of capital has sidelined some investors, but that leaves a plethora of opportunities for investors who can quickly deploy investment capital into commercial properties. According to CBRE, total commercial real estate investment volume is expected to flatten in 2023, yet it still will remain well above pre-pandemic levels.
DSTs on the rise
Passive real estate investments, such as
According to research firm Mountain Dell Consulting of Salt Lake City, there was a 30% increase in the number of DSTs formed in the state of Delaware between 2019 and 2021. The increase has been largely fueled by investors purchasing fractional shares of DSTs to complete their
Baby boomers may be a primary reason why this subsector of commercial real estate continues to grow exponentially. As this demographic ages, many are deciding to end the cycle of "tenants, trash and toilets" by trading actively managed assets for passive real estate investments.
Purchasing fractional shares of DSTs allows investors who sell highly appreciated investment properties to buy the exact amount of shares needed to satisfy their 1031 exchange requirements, defer capital gains and depreciation recapture taxes, and also offer the potential for stable cash flows with no management hassles.
The prepackaged nature of DST investments may be another factor in their rapid rise as a viable replacement property for 1031 exchanges. Investors have strict deadlines they must adhere to when undertaking exchanges — 45 days to identify a replacement property after close of sale on their relinquished properties and 180 days total to close on replacement assets. It can be extremely challenging for investors to identify and close on suitable replacement properties in those compressed time frames, especially in real estate markets where intense investor demand leaves slim pickings for exchange buyers.
DSTs can eliminate deadline pressure because financing, due diligence and other important considerations are already in place. Exchanging into a DST can reduce execution risk for all types of 1031 exchanges. Investors can even mix and match shares of different DSTs to suit their tolerance for risk and match their portfolio diversification or rebalancing requirements.
Investors have a wide range of passive investment opportunities from which to choose, and they may find that not all commercial real estate is office space, industrial buildings or flashy retail strip centers. A third party-managed storage facility in the Midwest, along with a multifamily apartment complex in the South, may constitute an appropriate mix of real estate investments for their goals. These offerings, and many like them, can be found as assets held within DSTs.
Technological advances and predictive data analytics
Technology can also help investors and money managers rebalance and diversify their portfolios to include highly tailored commercial real estate offerings. The institutional-grade predictive and forecasting technologies being brought to market for investors and wealth advisors are incredibly powerful tools. Predictive data analytics can help investors customize their commercial real estate holdings so their portfolios are better aligned with their tolerance for risk and diversification requirements.
Potential insights from data analytics on commercial real estate markets can provide a clearer understanding of tenant and consumer trends, and trends including important property amenities, neighborhood demographics and growth patterns. Armed with this data, investors and wealth managers can seek out commercial real estate investment opportunities that may fit each individual's risk tolerance and investment objectives.
Tax deferral strategy
Finally, investors who exchange actively managed investment properties into passive real estate investment vehicles can also roll forward their capital gains deferral through subsequent exchanges and continue to pursue potentially higher-value commercial investment properties. The final shelter for your tax deferral strategy should include bequeathing your real estate holdings to your heirs so they can enjoy a one-time step-up in basis that will potentially eliminate all of those deferred capital gains taxes.
