Adam Smith, the influential and oft-cited 18th century economist, wrote that all wealth comes from the land. He considered mining, manufacturing and agriculture the only sources of true economic gain; everyone else is providing services and merely swapping dollars.
Though things have changed since the late 1700s, time has proven that Smith was wise beyond his time.
Creating wealth involves a synergy with the whole greater than the sum of the parts. Applying labor and overhead to materials results in value beyond the cost of the individual components. On the other hand, selling services merely takes money out of one pocket and puts it in another.
The Industrial Revolution created enormous demand for large buildings for manufacturing operations. With the clustering of people in manufacturing centers, society took on a new shape. The world today is largely the result of the population shifts brought about by the Industrial Revolution.
Service providers, like industrialists, need a place to conduct business. Thus, commercial real estate is vital to operating the economy. The inventory of commercial and industrial buildings comprises a large part of a community’s business infrastructure. These structures require a tremendous amount of capital and are not easily sold should one find oneself short of spending money. Whereas most stocks and bonds can be sold on a moment’s notice, cashing out of real estate usually takes awhile. Real estate investors have a longer investment time frame than do stock and bond traders.
Searching for balance?
Should you follow Adam Smith’s path to riches by owning real estate? Should you have a portion of your investment assets in real estate? What does real estate offer that’s better than just investing in mutual funds?
Financial advisors have long advocated diversification as the key to long-term financial success. Real estate, along with stocks and bonds, makes a well-rounded portfolio that can weather the financial storms that beset our economy.
One advantage of owning real estate is that it often acts contrary to the stock market. Thus, when stocks are going down, real estate is frequently stable, or rising. Therefore, many investment advisors recommend that their clients put a portion of their investment funds in real estate.
Many of us have our own benchmark numbers for investment returns over the long term. I figure that publicly traded stocks will yield somewhere around 9% over time. In my experience, real estate investments yield slightly more than stocks, coming in somewhere around 10% to 11%. I suspect the relative non-liquidity of real estate accounts for the increased investment yield.
A few options
If jumping headlong into buying income-producing real estate is intimidating, there is a hybrid creature out there that is a mix between a publicly traded stock and real estate. An investment in real estate investment trusts (REITs) combine elements of stock and real estate in one vehicle.
Mississippi is home to two of the best REITs in the world, EastGroup Properties and Parkway Properties.
I’m not advocating that you rush out and invest in these companies, but it’s worth considering their performance. They tend to consistently generate superior investment returns for their shareholders.
If buying REITs isn’t attractive, another option is direct ownership of the property. Either alone or with other investors, property can be bought and managed. A property manager can be engaged to handle the everyday chores of real estate management, or one can do it themselves. I suggest proceeding cautiously with the temptation to self-manage a commercial property since it is a time consuming commitment.
Buy a building?!? What?!?
Almost 30 years ago, I was about to embark on my first bout of self-employment. A wise, old friend, upon hearing of my schemes, plans and designs, advised me to buy a building.
I was flabbergasted! Here I was concerned about survival and getting the electricity turned on and he wanted me to buy a building?
For Pete’s sake, why would I do that?
Well, he said, you’ll probably make good money doing what you do and you’ll spend it living too high on the hog. You won’t accumulate any money and when you get ready to retire you won’t have anything to retire on, but you’ll have the building.
He had a valid point. Buy a building rather than paying rent. Pay it off while making a living using it and then sell it and retire.
Not a bad strategy. I hope it works.
Thought for the Moment — To know oneself, one should assert oneself. — writer Albert Camus (1913-1960)
Joe D. Jones, CPA, is publisher of the Mississippi Business Journal. Contact him at firstname.lastname@example.org.