Commercial real estate has been a popular investment asset class for many years due to its ability to generate strong returns and provide diversification benefits to a portfolio. Up until last year, the challenge has been finding value-add opportunities in a highly competitive market, with compressed cap rates. Today, with the increase in interest rates, and a slow down in the economy, we have a different set of challenges, and our focus must shift to how can we make sure that a property is equipped to not only survive, but also thrive in this environment. In this article, we will explore some key considerations for passive investors looking to invest in commercial real estate in our current economy.
- Understand the market dynamics
The first step to investing in commercial real estate is to understand the market dynamics. This includes gaining a deep understanding of the current economic conditions, trends in the local real estate market, and the dynamics of the various submarkets within commercial real estate.
Action steps: The basics are still important: is it a market that is growing, does it have diverse industries, does it have a low poverty rate, what are the housing statistics such as appreciation over the last decade and average household income? If not in a major market, is it near a major city that has been growing over the last few years? This information can help you make informed investment decisions and avoid making costly mistakes. - Define your investment objectives
Before investing in commercial real estate, it’s important to define your investment objectives. Are you looking for long-term capital appreciation or regular income? Are you willing to take on more risk for potentially higher returns, or are you looking for a more conservative investment? Defining your investment objectives will help you choose the right investment strategy and assets that align with your goals. We personally believe that the next year or two will be fantastic times to buy real estate at a major discount, these opportunities only happen every decade or so. “Never let a good crisis go to waste. – Winston Churchill.
Action steps: Evaluate if this is something you are comfortable with. Look at the previous economic downturns: how long did they take to recover? When was a good time to buy? While it’s impossible to predict the perfect timing for anything, we must understand at what discount rate we are comfortable purchasing at, knowing that we will be paying more for the mortgage (at least temporarily). Also remember, the downpayment will be smaller with the current cap rates going up. What do these numbers look like compared to the higher purchasing properties at a low cap rate? How many years of the higher interest rate will it take to get to the entire discount that you received? In some of our calculations it was as high as 50 years. - Consider passive investment options
One of the benefits of investing in commercial real estate as a passive investor is the ability to invest in a variety of different vehicles. These include real estate investment trusts (REITs), private equity funds, and syndicated investments. Each of these options has its own unique features and benefits, so it’s important to research each one carefully before investing.
Action steps: Learn what are the pros and cons of each of these options. - Diversify your portfolio
Diversification is key to mitigating risk and achieving long-term investment success. The ultra wealthy have as much as 50% of their portfolio in alternative assets. Investing in a variety of different assets and strategies can help you minimize the impact of market volatility and reduce your exposure to any one specific asset class. This is particularly important in the current economic climate, where uncertainty and unpredictability are common.
Action steps: Define three assets that are non correlated to each other. For example, real estate and the stock market. Real estate is on a different market swing. It does not trend up and down with the stock market, or energy. The government subsidizes housing, energy and food. Energy is also a completely different asset class. It doesn’t rise and fall with the stock market. - Partner with experienced professionals
Investing in commercial real estate can be complex and challenging, particularly for passive investors. That’s why it’s important to partner with experienced professionals who can help guide you through the investment process. This may include investment advisors, asset managers, and property managers who have deep knowledge and expertise in commercial real estate.
Action steps: When working with a new operator, make sure to find someone in your network that has worked with that person in one capacity or another, and check for references. Do a deep dive on the underwriting of each property, if you’re not sure how to do that, hire someone to go over it with you. - Focus on long-term value
As we mentioned before, 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. Commercial real estate investments are typically long-term in nature, and successful investors focus on creating long-term value. This may involve finding ways to improve the physical condition of the property, increasing rental income, implementing operational efficiencies to reduce costs, or expanding the property. By focusing on creating long-term value, investors can position themselves for strong returns over the life of the investment.
Action steps: Decide what asset classes you are comfortable investing in during this downturn, and take the next step!
Investing in commercial real estate as a passive investor can be a smart way to generate strong returns and diversify your portfolio. However, it’s important to understand the market dynamics, define your investment objectives, consider passive investment options, diversify your portfolio, partner with experienced professionals, and focus on long-term value. By following these key principles, passive investors can navigate the current economic climate and position themselves for success in the commercial real estate market.As the prominent real estate mogul, Sam Zell says “All the opportunity in the world means nothing if you don’t actually pull the trigger.”