Commercial Real Estate, the Best Kept Investment Secret
- May 29, 2018
- Author: Tom K Wilson
Over the last two centuries, about ninety percent of the world’s millionaires (in today’s dollars) have been created by investing in real estate. The virtues of real estate investing are well documented: cash flow, leverage, accumulation of wealth through appreciation, tax sheltering (both cash flow and appreciation), and they are real tangible assets, not just paper derivatives.
Real estate investing seems to have all of the desired virtues, however, what kind of real estate, where and when? Most of us start with rental houses where we live, then migrate to rental homes in markets with better returns, then graduate to multifamily, and some discover non-multifamily commercial.
Commercial properties are the unsung heroes of our economy. While the old adage is true, that everyone has to live somewhere, people wouldn’t have a reason to live where they do if it were not for the infrastructure around them that includes commercial real estate.
Just think, every place that people work, shop, receive medical services, get education, and get all of the goods that are manufactured, warehoused and distributed, are all in commercial real estate.
There about half a trillion dollars a year bought and sold in the US of commercial properties including multifamily. That is about the same as all of the 5.5 million single family home sales last year.
Technically, commercial real estate is any property that is purchased for the main purpose of generating revenue, or commerce. “Commerce” is defined as “the activity of buying and selling, especially on a large scale”.
This includes multifamily (apartment) properties, because they are for the purpose of commerce, however, most think of commercial as non-multifamily, so that is the definition and focus that we will take for the purpose of this article.
After the crash, people who had not considered real estate as an investment vehicle before now wanted to jump in. Everyone has had exposure to residential properties because they live in one, or rent out one, or both.
Even hedge funds and Wall Street identified home rental investing as a hot 'new' asset class. As home ownership dropped from 69.2% to 62.9% because of foreclosures, multi-family rental demand and values increased.
The new demand relative to the supply has appreciated the prices of homes and multi-family units and historically, property values always appreciate faster than rents.
To the new real estate investor the natural progression has been to invest in multifamily properties because it “feels” familiar (even though they are way more complex than most realize). Thus, we developed an increase in demand and an incentive to increase the supply.
In response, a lot of Class A multifamily products have been built in most of the primary and secondary markets to the extent that they are now overbuilt and absorption is decreasing in most markets.
As a consequence, commercial products today are giving typically 2% higher returns than multifamily in most major high return markets in the country because of their relative positions in their market cycles.
Multifamily properties and their returns have peaked out whereas commercial properties are still in the expansion part of the cycle. The apex of returns is now in the marketplace of commercial real estate.
Commercial properties are advantageous because of the economies of scale, more predictable income and expenses, higher cash flow, higher quality tenants, longer-term leases, automatic rent increases, NNN leases, and they are simpler to manage professionally (as long as the manger has the higher level skill set required).
NNN leases pass the expenses of the taxes, insurance, and repairs to the tenants, giving the investment more certainty of projected returns.
Where should I invest and in what asset classes?
So commercial sounds interesting, but where is best? The short answer is where the returns are the highest as compared to the risks, where the population and jobs are growing, and where the political climate is favorable.
The one exception is for entitlement projects. Ironically, one can get more value added if the entitlement is difficult, such as in California. However, you want to make sure you have the expertise on your team to minimize risk and navigate this course.
For stabilized cash flow, our primary target is the Sunbelt, the Southern half of the US East of and including the Rockies, such as cities in Texas. Why? Most of these markets have high growth, affordable housing for the employees, are pro-business, and have rent to market value ratios that produce the highest profits and cash flow. The coastal cities in the West and the Northeast are simply too expensive relative to the rents to cash flow well.
Let’s take the simple example of a rental home. In San Jose, a median priced home is $1M and rents for $3300. For a million dollars, one can purchase 7 higher quality homes in Texas that rent for a combined $10,000. However, even in TX that results now in only about a 5% annual return, about 3 percentage points lower than commercial returns.
Most investors prefer good predictable cash flow with modest appreciation over low cash flow and potentially high appreciation or value add. Some want a little of both.
Now let’s take a brief look at the “what” to invest in and survey the primary asset classes.
How often have you driven by or flown over industrial buildings and thought nothing about it? They aren’t pretty, no windows, usually away from where we live and work, and what in the world are they doing in there? As it turns out, a lot!
This is where everything is manufactured, warehoused, distributed, and data is communicated. And e-commerce is just increasing the demand. Local multi-tenant complexes house businesses that take care of our local services such as communications installers and servicers, home remodeling services, etc. These leases are not as long as single tenants, however, but they can still be typically 3-5 years with renewal options and annual increases. To sweeten the deal, there are virtually no industrial tenant “skips” overnight.
Office buildings are where many of us work if we are not manufacturing or distributing something. They can be large class A glass towers, low rise small offices, or single tenant buildings. Again, leases are typically 3-5 years with renewals for small tenants, to 15-20 year leases for large national credit tenants. Traffic count and growing economies are important.
Contrary to many sensationalized headlines, many retailers’ brick and mortar stores are actually benefiting from their synergy with e-commerce.
Yes, a third of the big malls are in trouble, however, many experts say that many malls will be repurposed to include entertainment and services and will not only survive, but thrive. And yes, a lot of big box stores are at risk, however, many of those are also expanding as they develop more synergy with their e-commerce partners. The key is to identify the winners from the losers.
The internet is actually driving many shoppers to the stores to see, try on, or pick up the products and buy more while there. And neighborhood service centers have little Internet competition. You just can’t get your hair styled or eat a sandwich online.
And just when everyone thought that all brick and mortar was about to be scrapped from the face of the earth, the largest e-commerce company in the world pays $13.7B for 460 Whole Foods stores, and opens up a new line, of all things, book stores. Yes, Amazon Books. One has to wonder, was this their strategy all along!
So we must be careful in drawing broad swept conclusions with sensational news selling headlines. We are bullish on the right retail properties in the right markets that have a predominant or significant service sector.
This has always been the highest potential return asset class. Why? First it typically has no income, two, it is very difficult to get a loan (because it has no income), and third, it has higher uncertainty and time to perform because of the entitlement (getting the often long and complex path to a permit) and development phases.
However, with the right product and well chosen intended use and purpose, it can have a higher return. Generally the investor needs to be one who does not need cash flow, can tolerate the uncertainties, and is willing to take on higher risks for a potential high return. One of the largest risks of any entitlement project is time to completion.
This is an asset class that especially needs very experienced experts to navigate the often-political process and has the relationships and resources to execute the plan.
Oh yes, the loan, lest we not forget. Historically, a commercial loan, including multifamily, was more dependent on the predictable performance of the property than on the borrower. Before the crash of 2007/8, almost everyone could get a commercial loan if they could fog a mirror. Not as easily as for a SFH (single family home), however, money even for commercial was not difficult as long as you had sufficient liquidity and credit score.
The post crash situation is a different story. Money has tightened and the borrower is more significantly scrutinized. And most importantly, if one does not already own and have experience with commercial property, the chance of getting a loan is almost nil.
No need to fret and throw in the towel, however, as long as you have a partner who can qualify. And one of those partners can be a syndicator.
Leveraging Experts Using Syndications
We acknowledge that all of this may feel out of reach for the individual investor, and as hopefully you can get a sense, acquiring and managing a large property requires a lot of time, expertise, and experience. A great enabler to this challenge is a syndicator.
Syndicators allow one to move up to the 'big leagues' that are normally restricted to institutional and wealthy investors.
Syndications are growing in popularity. There were over 50,000 real estate syndications last year in the USA. The small investor can leverage the expertise of the syndicator's skills and experience. With the right syndicator, metro, and product, one can turn $50K into quarterly cash flow and exit with doubling your money in five to seven years.
A good syndicator has high integrity, a successful track record, filters through hundreds or thousands of opportunities to select the best, narrows the selections, performs extensive due diligence, negotiations the loan, invests along-side the client, and provides professional management of the shareholders investment.
They will provide extensive information about each investment, the economy of the region and be available to answer all of your questions to your satisfaction. The shareholder enjoys the passive benefits without the liability and management headaches.
Typically a commercial syndicator will provide detailed information online or in print, and host events and webinars.
Information you can expect includes summaries of the investment, market analysis, location economics, demographics, property description and condition, comparisons of properties, and independent statistics.
Also expect the current financial performance and projected, tax issues, background of the principals, detailed fund disbursement schedule, property performance forecasts, and an exit plan.
Great Syndicators are Easy to Contact by Phone, Text or Email.
You should expect answers to your questions within 24 to 48 hours with an attitude of openness and willingness to respond to everything a potential investor asks. While there certainly may be time limitations to invest, you should never commit your hard-earned money prior to establishing the ability of the syndicator to manage the investment with integrity and competence.
The Wilson Investment Properties Difference
Today, Wilson Investment Properties offers highly selected syndicated commercial real estate opportunities with strong economic fundamentals that have proven resilient through all phases of the real estate market. We have a lot of investor education on our website www.TomWilsonProperties.com, or call us with your questions at 408-867-1867.