When you decided to become a physician, you were planning for the future. The path to becoming a doctor is not an easy one- to practice medicine, doctors commit to 4 years of undergrad, followed by 4 years of medical school, and anywhere between 3 and 7 years of residency before acquiring a license to practice medicine. After all of that hard work, the last thing many doctors want to do is buy a Wall Street Journal or Barron's subscription and use what little free time they have to try to make sense of the vagaries of the market.
Luckily, there are investment vehicles other than traditional equities, bonds, and mutual funds. Commercial real estate properties can offer physicians numerous benefits, including the ability to generate returns passively, portfolio diversification, and tax advantages not available to any other asset class. Here are just a few of the reasons why doctors and commercial real estate investments are such an excellent match.
Passive Returns
Commercial real estate assets offer a combination of regular cash flow that drives passive returns. While some investors choose to manage their commercial properties actively, many real estate investors hire management companies or other professionals to handle their properties. In addition, there are many managed real estate funds that give you access to the real estate markets without having to do all of the legwork that comes with being an active real estate investor.
Portfolio diversification is a critical factor in the long-term success of your investment portfolio. A diverse portfolio stands up better to volatility, which is particularly relevant in this age of wild market swings driven by the 24-hour news cycle and social media. As your retirement savings grow, you will need to find new ways to ensure that your portfolio maintains diversity and the ability to withstand slowdowns and recessions.
Real estate is arguably the most tax-advantaged of all major investment assets. The average overall physician salary in 2018 was $299,000, according to Medscape. This places most doctors in the higher end of the federal and state tax brackets. Commercial real estate assets offer up many opportunities for tax deferral or even elimination of your tax burden.
Depreciation
Commercial investors can claim property depreciation on their taxes to reduce their overall obligation. The current IRS depreciation schedule is set at 1/39 for commercial properties, which means that you can deduct 1/39th of the value of a commercial real estate asset each year. Many forms of passive real estate investment allow investors to take advantage of depreciation benefits, even if they are not actively engaged in managing or acquiring commercial properties.
Lack of FICA Taxes on Commercial Real Estate Income
In the vast majority of cases, income generated through commercial real estate investments is not subject to FICA payroll taxes. Instead, most commercial real estate income is taxed under short or long-term capital gains. Of these two, long-term gains offer lower tax rates than either FICA payroll or short-term capital gains rates.
Defer and Leverage Capital Gains Taxes Using a 1031 Exchange
Through the use of a 1031 Exchange, investors can defer recognition of any gains made via a property investment. This process involves working with a qualified intermediary to exchange one property for another like-kind property, in this case, real estate asset for real estate asset. The use of a 1031 Exchange to acquire commercial properties gives the investor access to funds that would have otherwise been paid to Uncle Sam. Savvy investors can leverage these funds to generate returns in the meantime, and avoid paying capital gains until the property is eventually sold. Even better, a 1031 Exchange can be used to leave property assets to heirs, tax-free.
If you feel that active real estate investment is too time-consuming due to your professional and personal obligations, another option is passive real estate investment through a property investment company. There are a few hard and fast rules you should follow before entrusting your financial future to a third party.
Reputation Matters
Like any investment, due diligence is critical. Try to find property investment firms that have a history in the business, and a track record of success. You don't want your investment savings to be the test dummy for a new player in the real estate market. Stick with firms that have a name in the industry and a long list of happy clients. Use online reviews from trusted sources to research a potential firm, along with the SEC's "Check Your Investment Professional Tool."
Investment Property Strategy
As with the wider market, there are varying levels of risk and reward for investments in the real estate industry. Some firms will be chasing higher rewards, which in turn come with a higher level of risk and vice versa. In most cases, the longer you have to be in the market before retirement, the more risk you should take on. Ensure that you find an investment professional whose strategy matches up with your investment goals.
Fees and Charges
One of the reasons for the wild growth in market tracking ETFs and other equity-based passive investments is their low-fee/low-cost model. While a couple percent point fee each year doesn't seem like that much, over the lifetime of your portfolio that number can balloon to be massive, due to the power of compound interest. Before entrusting your funds to an investment firm, shop around to find the company with the best fee model for you, either fixed or as a percentage.
There is no doubt that many doctors possess the ability to play the markets. However, after 60-80 hour weeks and a heavy patient load, not every doctor wants to deal with P/E ratios, options trading, or researching the latest tech IPO. Commercial real estate, particularly managed CRE, offers physicians a passive, stable, appreciating, cash flow generating investment asset with minimal work and fuss.