In the world of commercial real estate, asset management refers to the day-to-day value creation efforts for a portfolio of properties. This includes optimizing the financial performance of the portfolio, overseeing property management and capital improvements, overall sub-market knowledge, capital markets expertise and managing tenancy. Having the right team in place to perform these functions helps to maximize property values and income streams for investors.
Asset management has never been more important in CRE. In periods of high inflation such as we’ve had over the past two years, asset management can be a make-or-break factor when it comes to investment returns.
FNRP360™ is an in-house management and operating platform we created that makes First National Realty Partners a truly unique, world-class operator of commercial real estate assets. Below we’ll examine the discipline of asset management and explore how the FNRP360 approach brings critical expertise and longstanding experience to meet the challenges of inflation.
World-Class Asset Management Leads to Advantageous Lease Terms
Many investors are attracted to commercial real estate because it can be a natural inflation hedge. What many investors don’t realize is the importance of how leases are structured, and the potential they have to either protect or expose the property owner in an inflationary period.
As part of every lease, there is base rent, which is a predetermined amount that increases throughout the lease term. Most retail leases also include an additional rent component called a “chargeback”, whereby tenants are required to pay for operating expenses. This structure is known as a “triple net” or NNN lease, and it is advantageous for landlords and investors because tenants take responsibility for the property’s operating expenses.
During an inflationary period, operating expenses tend to increase along with materials and labor. Landlords who negotiate triple net leases are relieved from having to bear the higher cost burden, and instead, pass the expense on to the tenants.
For this reason, we at FNRP prefer triple net leases. They are an incredibly powerful inflation hedge, and it is important to note that the benefits that come from a triple net lease are unique to commercial real estate investing.
The Power of Built-In Rent Increases to Combat Inflation
Another powerful tool in the asset management toolkit is the ability to include in the lease terms a series of scheduled rent increases, or escalators. A rent escalator can be a strong inflation hedge, but this strategy relies on tenants agreeing to the terms. If the property in question is at a competitive disadvantage due to location, condition, or other factors, tenants may be reluctant to agree to rent escalators.
In order to leverage the power of rent escalators, the FNRP360 approach applies a strong due diligence process to filter out acquisition targets with tenancies that are not conducive to regular rent increases. Before acquiring a new property, our team meets with each in-place tenant to understand their intentions, prospects for renewing leases, and to gauge whether the physical space is meeting their needs. This helps to determine whether each tenant is likely to renew, and if so, whether they will be open to renewing at a higher rate. This thorough due diligence process allows us to be strategically selective with a bias towards properties that are well positioned perform in times of higher inflation.
Inflation Places an Emphasis on Expense Management
Income growth is only half of the equation when it comes to managing commercial real estate assets. The other consideration that becomes critical during a period of high inflation is expense management.
Operating expenses such as maintenance, utilities, and labor costs tend to increase during inflationary periods. If not monitored closely, rising costs can put a lot of pressure on an investment firm to maintain the profitability of a property.
We believe that success in an inflationary environment hinges on keeping costs down but not so low as to negatively impact the property — for example, cutting marketing spend or deferring critical maintenance may make it difficult to find and attract new tenants. Achieving the right balance ensures the property is well-maintained while promoting the cash flows necessary for investors to achieve return objectives.
Whether expense management operations are handled in house or externally via a third party is another important consideration for optimization of investment returns. An external third party may successfully meet requirements for profitability of the property, whereas an in-house team is further motivated to maximize returns.
What are the Advantages of Working with a Private Equity Commercial Real Estate Firm?
Commercial real estate can be a powerful inflation hedge, but taking full advantage requires a set of systems and processes to ensure that asset management tasks are completed in a consistent and expert manner by experienced professionals.
It was this need that led us to develop FNRP360™, our in-house management and operating platform that brings together the most critical commercial real estate functions – asset management, accounting, property management, acquisitions, legal, and leasing. This level of vertical integration provides a competitive advantage in operating efficiently and effectively across market cycles and economic environments.
Many commercial real estate investment firms outsource these functions, which can result in slower decision making and missed opportunities. Our integrated approach results in rapid information sharing that enables us to execute asset management responsibilities with speed and effectiveness.
As a fully integrated firm, information obtained during due diligence likewise feeds rapidly into our underwriting process and ultimately influences the amount we are willing to pay for the asset. Individual investors and other investment partnerships often struggle to link the knowledge gained during the due diligence period with the terms of the acquisition, increasing the risk that they may overvalue and overpay for the asset or lack the operating capabilities to fully capitalize on unpriced sources of value.
Good alignment of interests is another advantage investors should look for when choosing where to invest. In a model where operational functions are outsourced, the individuals performing the work lack a direct connection to investors in the property and are generally motivated solely by the fees they are paid. In a vertically integrated operation, the individuals performing the asset management and other operational functions have their own personal interests aligned with the interests of investors in the property, because their compensation is typically tied to the performance of the firm and its investments.
Conclusion
Commercial real estate is a strong inflation hedge for investors because property values and rental income tend to increase in tandem with rising prices, preserving, and even increasing the value of the investment. FNRP places an emphasis on asset management because we believe that it increases the likelihood of strong rental income growth and capital appreciation over time.
The FNRP360™ operating platform not only gives our investors an edge by allowing them to leverage deep industry experience, rapid execution, and operating cost savings, but the in-house organization of all operational functions also aligns well with our investor interests. To learn more about how you can leverage FNRP360™ to insulate your portfolio from inflation and earn attractive risk-adjusted returns, please contact our Investor Relations team by clicking here.
