There is a misconception among individual investors that a commercial real estate (“CRE”) investment is a good way to generate “passive” cash flow. While it can definitely be a good way to generate income, it is anything but passive. Commercial properties are large, complex assets and, depending on their size and leasing activity, they can take a significant amount of effort to manage on a day to day basis. Trying to do so on a part time basis can be bad for business.
Commercial Property Management Responsibilities
On a day to day basis, there is a significant amount of work that has to be done to ensure a commercial building continues to run smoothly. These activities include things like:
- Routine property maintenance like replacing carpet, repairing sinks, or pulling weeds
- Rent collection, pursuing delinquencies, evictions (if necessary) and making the requisite deposits
- Monitoring market conditions for changes in rental rates and/or occupancy
- Property leasing for new tenants and general tenant relations
- Managing renovation projects and collaborating with contractors and architects
- Reviewing reports & creating investor updates
- Working with accountants to compile financial transactions and file tax returns
Given the list of activities above, it is clear that managing a commercial asset requires a significant amount of effort and that it is far from a passive endeavor. The exact scope of work can vary by property type and size, which we capture in a metric called “Management Intensity.”
What is Management Intensity
Management Intensity is the term we use to refer to the exact amount of work that goes into the day to day management of a property and it varies by property type, size, and location. There is not a specific number attached to this metric, but it can be helpful to imagine it on a spectrum.
On one end of the spectrum is a single tenant property, like an office building in Atlanta, with a national tenant on a triple net lease in a suburban or rural location. This is a low intensity asset that does not require a tremendous amount of oversight because the lease structure mandates that the tenant is responsible for a majority of the day to day property management activities.
On the other end of the spectrum is a 300 unit, high-rise multifamily rental property in an urban location. Given that it is a residential property, a high rise, and in an urban location, there is a never-ending list of tasks that need to be completed. As a result, this is an asset that has a high degree of management intensity and likely requires full-time dedicated staff. In cases like this, a new question arises, who is actually going to perform the required management activities?
Property Management – Outsource vs. Insource
One of the oft-cited benefits of commercial real estate investment is the ability to outsource a property’s management responsibilities to a third-party property management company. While this can be an effective way to scale a portfolio, it comes at a cost. A third-party property management service can cost 3% – 10% of a property’s gross rents as a management fee, which can turn out to be a substantial cost for larger properties. In addition, a property owner loses sight of the day to day activity on a property when hiring a third party property manager. For both of these reasons, and others, we prefer to “insource” property management activities.
Unlike other commercial real estate investment firms, we have an extremely talented team of property and asset management professionals who are responsible for the oversight of the assets in our portfolio. This type of “vertical integration” provides two key benefits, it can provide significant cost savings to the property, which increases Net Operating Income (and value) and it can provide us with more direct oversight of property operations, which we prefer.
So, given the amount of work that goes into managing a commercial real estate asset, investors who are interested in purchasing it face a choice, which it is to make a direct or indirect purchase.
Commercial Real Estate Investment – Direct vs. Indirect
For those interested in gaining exposure to commercial real estate assets, there are two options, to purchase it directly or indirectly.
In a direct purchase, an investor or group of investors forms an LLC and uses it to purchase a commercial real estate asset. For those that prefer direct operational control, this can be a preferred method. But, as it has been pointed out in this article, managing a commercial property requires a significant amount of time, effort, resources, and expertise. It is not something that can be done part-time. As a result, we believe that individual investors may be better served with an indirect purchase.
With an indirect purchase, the investor places their capital with an asset management firm (like ours) and outsources the task of identifying, purchasing, and managing the asset to them. The benefit of this method is that it can save the investor a tremendous amount of time, but it also allows them to leverage the experience and expertise of the manager, which can be a tremendous asset on its own.
The point is this, the addition of commercial real estate to a broadly diversified portfolio of risk assets can be a great way to generate income, but it is far from passive. Commercial assets require a significant amount of maintenance and upkeep and it isn’t something that can be done on a part time basis. For many individual investors, their best bet is to place their funds with a professional manager who can handle day to day property management on their behalf.
Interested in Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets – including service-oriented retail shopping centers – well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
Whether you’re just getting started or searching for ways to diversify your portfolio, we’re here to help. If you’d like to learn more about our investment opportunities, contact us at (800) 605-4966 or send us an email at firstname.lastname@example.org for more information.