Investing in commercial real estate (CRE) assets can be an excellent way to generate passive income and portfolio diversification. But, “investing in commercial real estate” can be tricky because there are many ways to do it.
In this article, we are going to describe nine different ways that individuals can invest in commercial real estate assets and the pros and cons of each. By the end, readers will have the information needed to determine which method is most suitable for their own risk tolerance, return objectives, and time horizon.
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Method #1: Private Equity Commercial Real Estate
A private equity firm is one who invests in the privately held equity of other companies, including those that own real estate investment property. In a typical private equity commercial real estate investment setup, the firm acts as the deal leader responsible for finding, underwriting, financing, and managing a commercial property and individual investors provide equity capital in return for a share of the property’s cash flow and profits.
The benefit of this approach to commercial real estate investment is that individuals can gain fractional ownership of institutional quality assets while outsourcing management responsibilities to the private equity firm.
The downside is that an investor’s capital may be illiquid for five to ten years, the minimum required investment can be large, and they may have to pay a nominal fee to the private equity firm for their management activities.
Method #2: Commercial Property REITs
A Real Estate Investment Trust – REIT for short – is a company that owns, operates, and/or finances commercial property. REITs have a unique legal structure that can provide significant tax advantages as long as they meet certain criteria laid out by the Internal Revenue Service (IRS). In addition, REIT shares can be privately held or publicly traded. For the sake of this article, the focus is on publicly traded REITs.
For individuals, the benefit of investing in a publicly traded REIT is that shares can be purchased for a relatively small price, taxes can be lower than other commercial real estate investment options, and shares are liquid because they can be bought and sold in public markets.
The downside to purchasing publicly traded REIT shares is that individuals don’t have any say in the properties that are bought and sold and share price changes can be subject to the whims of public stock markets, not necessarily the underlying fundamentals of the properties.
Method #3: Commercial Property REIGs
Real estate investment groups, sometimes referred to as investment clubs, are casual clubs formed by like minded individuals who want to invest in real estate. They may be organized as a partnership or corporation and investors can purchase shares and receive returns in proportion to the number of shares they own.
The benefit of a REIG investment is they are not as tightly regulated as REITs or private deals and investors are able to actively participate in the decision about which property to purchase. In addition, the pooling of capital allows investors to gain access to larger, higher quality properties than they could afford to buy on their own.
The downside of a REIG is that they are member-led, which means that the leadership may or may not have the requisite experience to properly lead this type of commercial real estate investment. In addition, there may be liquidity issues with members unable to sell their shares if/when needed.
Method #4: Crowdfunding
For individual investors, one of the major challenges of a commercial real estate purchase is they are too expensive for most individual investors to afford on their own. Crowdfunding can offer a compelling alternative in the sense that it gives individual investors an option to purchase a fractional share of a commercial property.
The major benefits to a crowdfunded commercial real estate investment are that individual investors can purchase a fractional share of an institutional quality asset, can choose the property they would like to invest in, and can gain exposure to it for a smaller minimum investment than a typical private equity deal.
The downside to a crowdfunded investment is that transaction sponsors may not be thoroughly vetted and the fees tend to be higher than alternative options, which can impact returns.
Method #5: Commercial Property ETFs
“ETF” is an acronym that stands for Exchange Traded Fund. So, commercial property ETFs are exchange traded funds that specialize in the purchase and management of commercial real estate assets. Sometimes ETFs specialize in certain asset classes/types of real estate – like multifamily apartment buildings, office buildings, distribution centers, or retail shopping centers. For example, a popular commercial property ETF is the Vanguard Real Estate ETF.
For individual investors, the major benefit of a commercial property ETF is the diversification of spreading capital across many properties, the liquidity of the shares being publicly traded on a major exchange, and the low management fees.
The downside of a commercial property ETF is that investors don’t have any say in which properties are purchased. In addition, share prices can be impacted by routine market swings, even if they are disconnected from the fundamentals of the underlying properties.
Method #6: Commercial Real Estate Company Shares
There are many corporations who specialize in commercial real estate. Some companies may be developers who concentrate on building projects from the ground up, some may focus on purchasing/managing existing properties, and others may be indirectly connected to the commercial real estate industry like materials suppliers or lenders.
The benefit of this approach is that investors can gain exposure to this asset class without actually having to purchase property. In addition, publicly traded shares are liquid and the transaction costs are low.
The downside of this investment strategy is that there are hundreds of companies that fall into this category and finding a few to invest in can be tricky. In addition, many of the companies may be privately held, which means that their shares are not available for purchase and/or they are only available to accredited investors who meet certain income and net worth requirements.
Method #7: Commercial Real Estate Construction Company Shares
Investing in commercial real estate does not always mean buying property. In some cases, it could mean investing in companies that have direct exposure to the commercial real estate industry. For example, Skanska (Ticker: SKBSY) is a global construction company who builds important, large scale commercial property projects.
The benefit of this approach is that it is a relatively cheap and easy way to gain exposure to commercial property assets. And, because shares are publicly traded, they offer liquidity, diversification, and low transaction costs.
The major downside of this investment option is that share price changes and company profitability may be impacted by non-real estate factors. For example, if the price of skilled labor increases dramatically, the profitability of the company will fall, but this doesn’t necessarily have anything to do with the cash flow produced by a commercial building.
Method #8: Commercial Property Trusts / Mutual Funds
Property trusts and mutual funds are very similar to REITS in the sense that investors can gain exposure to commercial real estate assets by purchasing fractional shares of a company that operates commercial real estate properties. But, the legal structure of a REIT is very different from a trust and mutual fund so investors should take time to understand the differences and make sure they are comfortable with them.
Like a REIT, trusts and mutual funds provide the benefits of diversification and fractional ownership of institutional quality properties. In the case of a mutual fund, the management fees can be quite low, which means that the bulk of returns are distributed to investors.
But, the downside of this approach is that investors have no say in the types of property purchased and, in certain instances, the required minimum investment can be prohibitive for many individual investors.
Method #9: Loans to Commercial Property Investors
Another way to gain access to commercial real estate assets without actually buying properties is to provide debt to operators and investors who need it. For individual investors, the easiest way to do this is through the publicly traded shares of a Mortgage REIT – mREIT for short. Examples of publicly traded mREITs are companies like Starwood Property Trust or Annaly Capital Management.
The advantage of this approach is that investors can earn regular income from loan payments and they are typically secured by a senior lien on the collateral property, which means that their position is the safest in the capital stack in the event of bankruptcy or foreclosure.
The downside of lending is that investors are exposed to changes in interest rates, which can materially impact returns. In addition, they are exposed to default risk, which is the risk that a borrower will stop making their payments – for whatever reason. When this happens, the lender forecloses on the property and sells it to repay the loan. In a declining market, this can be especially painful because it is possible that the lender could end up taking a loss on the deal.
Choosing the Right Investment Method
For individual real estate investors, the sheer number of options can make it difficult to choose one into which to deploy capital. This decision is complicated by the fact that each investor has their own unique needs and preferences. As such, there are a number of factors that should be considered before choosing one of the investment methods described above:
- Capital Available To Invest: Private real estate investments usually require a minimum commitment of $25,000 – $50,000, whereas shares of publicly traded options can often be purchased for $100 or less.
- Time Horizon: Private investments often require that investors commit their capital for 5 years or longer. Publicly traded investments can be bought or sold at any time.
- Risk Tolerance: Investments in certain rental property types like hotels, restaurants, or land, tend to have more risk than safer options like multifamily or senior debt.
- Return Objectives: Ultimately, commercial real estate investors are chasing a good return on investment and their desire to earn them can help guide their chosen investment method. Riskier options like land or hotels can deliver higher returns, but there can also be a high degree of variability. Safer options have lower returns, but they are also more stable and consistent.
When these factors are evaluated, it will start to become clear which commercial real estate investing option(s) make the most sense for each individual investor. For example, investors with a lot of capital, a longer term time horizon, and a healthy risk tolerance may be a good fit for a private equity investment. Or, at the other end of the spectrum, investors with smaller amounts of capital and a shorter time horizon will likely be a better fit for a publicly traded investment like a REIT.
Summary & Conclusion
For individual investors, there are a wide variety of commercial real estate investment options. From private equity deals to mortgage REITs, there are options that are designed to fit an equally wide variety of investor return objectives and personal preferences.
When deciding which option to choose, investors should consider their available capital, time horizon, risk tolerance, and return objectives. When these factors are combined, the most suitable commercial real estate option(s) will become apparent.
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 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.
If you would like to learn more about our commercial real estate investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.