The last decade has proven to be a golden age for Commercial Real Estate (CRE). If you have not yet chosen to invest in CRE, I’d certainly venture to guess that you have been approached about it. CRE is at the heart of many a dinner party conversation—from vacant land being developed into income-producing property or property that already provides income yields to its investors. It captures a wide variety of assets including industrial warehouses, retail shopping centers, multi-family housing (for the purpose of this article at least), office buildings and everything in between. With this much variety, you’re likely wondering how to pursue a CRE investment, and which investment is best for you and your family.
As a firm, i3 has underwritten billions of dollars in CRE assets across every spectrum for the families we work with, whether traditional income producing CRE or land developments in the making. We have seen many interesting CRE deals but are still often surprised by the next deal. For the families we work with, and so many others, CRE represents an opportunity for capital appreciation (because of rising rents and declining interest rates) and income yield, as CRE still outpaces yields on most government (local, state, federal) and corporate bonds. But like every golden age that came before, prices can’t go up forever. Our goal is to share with you, at least in this article, some of the vehicles available if you want to invest in CRE. And in a second article, we’ll discuss the protection of your assets if and when the bubble bursts.
Diversifying an existing CRE portfolio or making a first-time investment in CRE starts with ‘making the decision’ to do so, which typically requires bringing all family members on board and writing an investment policy. With everyone’s blessing and a fully-formed investment policy, you will decide which investment vehicles you’ll use for CRE asset ownership. One or more of the following paths are how most families choose to participate in the ownership of CRE.
Invest in a Project
This generally refers to a project that someone else, usually a developer (a.k.a. manager, general partner, promoter), has originated and is promoting. A project is defined as any number of things: ground up construction, existing building or re-development for any CRE asset class. In any case, a developer/promoter, with a scoped-out project, establishes a partnership business plan and is off to the races in search of capital (or equity), from a financial partner (or a “LP,” limited partner). In this scenario, your family will underwrite the people (developer/ promoter) first, with the project (a close) second. Investing in a project generally means you’ll pay fees to the developer based on two variables: management and performance. Historically, this is the most common entrance into the CRE market; it offers families limited exposure to risk (equal to equity invested) and relies on the developer to manage daily operations. For more visibility and control, please see Buy It. Own It.
Be the Leader
The project is entirely yours. You source, underwrite, execute, manage, and report to shareholders on the asset at hand. And beyond that, you’re leading the charge on establishing the business plan and managing, promoting and developing the project. Often referred to as the General Partner (“GP”), your role as leader entails lots of work. But guess what, there’s good news. You will be compensated accordingly. This path makes the most sense for families whose relatives already work in the CRE space or perhaps just wish they did. In either scenario, to be an effective leader, or GP, it would behoove your family to gain as much visibility and control as possible on any given project. A good strategic move? Invest first as a limited partner.
Consider It as Collateral
“Consider it as collateral” means you will loan money as either a senior or mezzanine lender at an agreed-upon rate with either full or partial collateral. While you may sacrifice returns (because loans generally get paid lower returns than equity) you have some downside protection. While lending money to a borrower, it is important to understand an asset’s business strategy, but it is more important to understand your three repayment source payments from rents collected, the appraised value of the asset, and if those two items are not enough, there’s always the borrower(s) additional collateral.
Buy It, Own It
Or, what i3 calls direct investment. Depending on your family’s balance sheet, you can skip the partnership options and go buy your assets directly. While this may limit your ability to diversify, it offers complete visibility and control over the assets you purchase and own—which is why so many families take this route. Watch CNBC’s “American Greed” for a few hours, and you’ll be hooked on buying your assets directly but it comes with the usual headaches of owning CRE; just like those headaches associated with almost anything else you own.
The Public Market
The Public Market is the easiest path available. Through your online account, brokerage firm or other financial institutions, your CRE strategy plays out in public markets by way of publicly traded instruments such as Real Estate Investment Trusts (“REITS”). Easy to track, (usually) three-day liquidity, and regulated, these publicly traded instruments are a great option for families who want exposure to CRE without headaches or commitments.
My guess is that, if you’re reading this, you have been offered a slew of opportunities to invest in CRE from real estate brokers, bankers, investment advisors, friends/family members, and others. You may be familiar with each of the above options, so your next question is likely: what’s next? My advice is to take a step back, visualize your end goal, and define what level of involvement you are willing to commit to. This will chart the right path for you to invest in CRE, then you can decide on the next step: underwriting the opportunities before you.
