When it comes to evaluating and securing an investment in the commercial real estate market, there are generally two distinct types of investors – those that look to own and operate a property and those who want exposure from an investment perspective only. The first seeks to understand how the actual ownership and operating side of the business works, i.e. how to identify, underwrite, perform due diligence, structure a closing, and acquire an asset. The second simply wants to understand how and where to invest their money for the best rate of return without the hassle of having to do everything themselves. In general, there are four ways investors can access and invest in commercial real estate deals.

The first way to invest is arguably the most complex. Here’s why.

OPTION 1: Direct Investing – Owning & Operating

Although how to invest in commercial real estate may not seem dissimilar to investing in residential properties, direct investment in real estate in the commercial sector is tremendously more involved.

  • It requires an in-depth understanding of the industry.
  • Generally, it requires a lot more equity.
  • It involves complicated legal structures, lengthy due diligence periods, and extended closings.
  • It’s up to you or a management team to operate.
How to Invest in Commercial Real Estate

Bottom line: Owning and operating commercial real estate is complex and it is not an avenue all investors want to pursue.

However, if being an owner and property manager is part of your investment strategy, you must first ask yourself what type of commercial real estate are you looking to invest in and why? For a better understanding of the types of commercial real estate asset classes you can invest in, their risks, and reward potential, we suggest reading “CRE 101 –Types of Projects”.

Generally, most people that seek direct ownership of a property are already a professional in the industry, not simply as an investor seeking exposure through an investment opportunity to earn passive income. Why? There’s a significant level of expertise required to financially underwrite, perform due diligence, and to facilitate a closing. The lack of consumer protection laws is the primary reason for this complexity. In residential real estate, these laws provide individuals with legal remedies if the seller falsely represents the condition of the property or withholds material information that would have otherwise affected their decision to buy a property. Unfortunately, these laws barely exist in commercial real estate. This means that the buyer and its team are solely responsible for examining, inspecting, and reviewing a property to determine whether it is suitable for their needs prior to purchase. If something is missed, the responsibility is solely theirs to bear and that is a big risk!

For the reasons discussed above, most commercial real estate investors are businesses with professional advisors, legal counsel, and consultants to assist them during the due diligence process to ensure all necessary precautions have been taken in evaluating the opportunity. The closing process is the final stage in any real estate acquisition, but closings on commercial assets are much more complex than closings on residential real estate due to the lack of federal regulations and the amount of equity required. Commercial real estate closings are less systematic and more fluid, which allows greater flexibility in how investor-buyers structure their transactions both legally and financially. In many cases, this results in complex legal structures with custom closing documents that require the expertise of skilled real estate attorneys.

Once you buy the property, you are on the hook for managing the property – or finding a management company to handle day-to-day operations. This is a whole other topic of conversation we will explore in-depth in future articles.

OPTION 2: Real Estate Investment Trusts (REITs)

For most investors, direct ownership is too cumbersome and complex to consider which is why they seek exposure to commercial real estate investments through other means. The most common channel is through publicly-traded real estate investment trusts or REITs.

A REIT is typically a publicly-traded company that owns, and in most cases operates, income-producing real estate such as office buildings or other types of office spaces, hotels, multi-family apartments, industrial, and even residential real estate. REITs can own any and all classes of commercial real estate and have a widely diversified portfolio that investors can invest in. Most people are familiar with this concept. REITs have been around for decades and there are countless articles on the internet which provide investors with education on their structure, dividends, transparency, etc.

Outside of the public markets through vehicles such as REITs and the direct ownership of commercial real estate properties, investors seeking returns in the sector have two remaining options:

  • Private Equity Real Estate
  • Crowd Funding Platforms

Let’s first discuss Private Equity Real Estate and what it involves.

What is the difference between IRR and ROI?

Real Estate Investment Trusts

As with any investment, there are always positives and negatives. If you would like to learn more about those related to Real Estate Investment Trusts, we suggest reading our in-depth article on REITs.

LEARN MORE

OPTION 3: Private Equity Real Estate

Private equity real estate investments generally refer to firms that aggregate both public and private capital for the investment into commercial real estate and related assets. Institutional-level private equity deals are generally less accessible to individual investors because of certain qualifications they must meet such as higher net worth levels and minimum investment requirements that are much larger than most individual investors are capable of making. More often than not, most institutional private equity firms are peer-to-peer platforms, meaning a fund-of-funds, where pensions, endowments, and insurance companies alike allocate capital to other fund managers that possess proven track records, established teams, and the expertise and skillsets needed to accomplish their return objectives. These firms invest millions or even tens of millions of dollars with each allocation.

In some instances, select private equity firms like PERI Capital Group offer Institutional access, which opens the door for individual investors to participate without having to meet the high minimum investment thresholds. Here, capital from multiple investors is aggregated into a special purpose entity that in turn makes a single allocation above the institutional investment minimum. This approach provides investors with many benefits.

Private Equity Real Estate Investing Infographic

Private Equity Real Estate Advantages

  • Investors receive access to direct co-investment opportunities alongside other institutional capital at a fraction of the cost.
  • Investors benefit from institutional-grade due diligence prior to investing. This isn’t to imply that investments with institutions are void of risk, rather their level of due diligence provides a greater understanding of the risks involved prior to making an investment.
  • Investors receive their pro-rata share of the investment’s income.
  • Investors receive tax benefits through pass-through losses and depreciation.

It is important to note, that private equity real estate investments are generally illiquid investments. Investors considering this avenue must do so with the understanding that they will not have access to their invested capital and must rely on returns for liquidity.

OPTION 4: Crowd-Sourcing Platforms

Since the amendment to the SEC’s general solicitation restriction for private placements in 2012, crowdsourcing platforms for real estate have exploded. Today, there are countless platforms offering limitless investment opportunities across any sector and at virtually any investment level. Due to the growth and expansion of various real estate crowdfunding platforms, developers and real estate investors now have easier access to capital than ever before and investors have the benefit of participating in commercial real estate at the click of a button.

However, the benefits of innovation are not without their share of concerns and problems. There are numerous research papers written by reputable organizations that have lauded the fact that technological innovation has ignited the growth of crowdsourcing platforms whereby providing a once restricted industry to the masses. However, these same organizations also issue a “buyer beware” statement as these platforms become more and more mainstream. The reason is that regulation and legislation protecting consumers lag behind substantial technological growth and that’s when fraud can happen.

Some additional concerns and issues with online platforms are certainty of closing, misrepresentation of risk and returns, conflicts of interest in how platforms are paid, volume and efficiency rather than the quality of deal flow, etc.

Real Estate Investing Crowd-Sourcing Platforms

Conclusion

Commercial real estate investing can be a part of any investor’s portfolio. It all depends on what level of activity you are willing to take on with the investment. Direct ownership of commercial real estate is the most time consuming and requires certain skill sets to successfully acquire, run, and operate a property. For investors that may be concerned about liquidity, public markets such as REITs or real estate related mutual funds might be the best approach. For others that would like a more direct approach that still keeps them in a passive position, private equity real estate investments offer a strong balance of income and growth potential.

For more information on what we’re investing in, reach out to us today.