Middle market deals ($5 to $50mm) are the ideal acquisition targets for commercial real estate investors seeking to generate superior risk-adjusted returns. Superior not only to other commercial real estate assets but to all other investment opportunities in general in my opinion.
Why middle-market assets for real estate investment? After several years of experience with different asset classes and real estate markets, we have found great opportunities in the middle market in the United States. It’s the perfect “white space” or “focus void”. These properties are too small for the institutional investor, below $50 million, and too large for the one-off individual investor, above $5 million. In this space, we consistently find value-add private real estate investments with the appropriate amount of risk that provides the investment returns we’re seeking.
On the lower end, there are untold amounts of investors with cash who can successfully fix and flip houses. The competition and the number of people we see attracted to the space is staggering. More competition means one thing:
If the middle market deal flow I am talking about had the same attention as the foreclosure and fix and flip market it would be much harder to be successful.
When you step up to property types in the $5 million thresholds, you not only knock out the residential investors, but you also step into a territory where individuals, even many wealthy individuals who invest in commercial real estate in their real estate portfolio, do not have the ability to CONSISTENTLY buy assets. So by purchasing commercial properties with property values in the $5mm+, preferably $10mm+ dollar space, the buyer’s pool is significantly smaller. A smaller pool of buyers should result in easier investment decisions due to less competition for assets with higher returns.
Next, you have the other end of the spectrum, below $50 mm. For large institutions, many times it does not move the needle to acquire properties at less than certain price points. For large REITs and other institutions, their cost of capital is significantly less than non-publicly traded investors. These institutions are looking for what’s known as “institutional” real estate assets. Typically these trade at very low cap rates, and are palatable to the REITS, because their cost of capital is low.
The middle market and deals in excess of $50mm have economies of scale that you just can’t find with smaller properties, providing better risk/return characteristics. The expense ratios of standard expenses to gross income always seem to make more sense when you look at larger deals than with the smaller ones. Lower expenses mean higher cash flow and IRR for a better rate of return and eventually total return on a commercial real estate investment.
Additionally, cap rates typically don’t compress as they do with the $50mm+deals when you step up from small commercial assets to middle-market assets.
This is why the middle market is the superior space to operate in:
- Less Competition From an Endless Amount of Individual Investors
- Less Competition From Mega, Publicly Traded Institutions With A Much Lower Cost of Capital
- Great Economies of Scale When It Comes To Expenses
- Higher Cap Rates Across The Board Compared To Larger Institutional Deals.
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