- Commercial real estate investment is often thought of as a way to produce passive income. It can be, but commercial real estate ownership is far from a passive endeavor.
- Determining whether or not an investment’s income is passive is a matter of who does the work to identify and manage the property.
- Those that take a do it yourself approach can benefit from direct control over the property’s identification, financing, and management. But, this approach also requires a significant time commitment and a high degree of operational expertise so it isn’t for everyone.
- The other option is to outsource property identification, analysis, and management responsibilities to a third-party professional manager.
There is a common misconception that commercial real estate (CRE) investments are a good way to earn passive income. This is not entirely accurate. They definitely have the potential to produce income, but they require a significant amount of work to find and operate on a day to day basis. Whether the income produced is passive depends on who does this work.
In some cases an individual investor or group of investors does the work on their own. In other cases, they outsource these efforts to a commercial property investment firm. There are risks and benefits to each approach. In order to understand them, it is first necessary to identify exactly what the required property sourcing and management tasks are.
Property Identification and Management Tasks Identified
Finding and managing a commercial property suitable for investment is a big undertaking that requires a significant amount of work. Important tasks include:
- Finding and Screening Properties: This may be the hardest part. Investors must collect financial information, run models, and analyze market data on dozens of properties to find one or two that look like good deals. This effort alone can be a full time job for multiple people.
- Rent Collection: Each month, the rent must be collected from all tenants and deposited into the property’s bank account. If the property is small, this is not a very time consuming task. But, if there are dozens of tenants, this can be a full time job. Either way, this effort is critical to ensuring the ongoing cash flow of the property.
- Repairs and Maintenance: Mechanical systems wear out over time and commercial property foot traffic can cause wear and tear. As a result, property owners must design and execute a property maintenance plan to ensure the property remains in good working order at all times. These tasks include things like: replacing lighting and air filters, painting, cleaning, window washing, snow removal, and landscaping. In addition, property managers need to be available at all times to respond to one-off repair requests when things break.
- Leasing: Real estate investors need to make sure their property stays full. This means that they need to devote a portion of their time to negotiating lease renewals for existing tenants and new leases for prospective tenants.
- Bookkeeping: Real estate professionals need to manage the inflow and outflow of all cash related to the property. This includes paying all service provider contracts, making the required loan payments, reconciling bank accounts and creating reports to track the property’s performance.
From this list, it can be seen that the process of identifying and managing a commercial asset requires a significant amount of work. Doing it well requires a lot of experience and a high degree of operational expertise. There are two options to manage this effort.
DIY Approach – Risks and Benefits
The first option is a do it yourself approach. In this case an individual or group of individuals forms a partnership or corporation and finds an investment property on their own. Doing so can yield several benefits:
- Detailed knowledge of exactly where their money is being invested
- Full control over the property identification and management processes
- Operational control over the day to day management of the property
- Entitled to 100% of the property’s cash flow and price appreciation
- No management fees
- Control over the decision to sell and the property’s asking price
- Control over capital budgeting and expenditures
The theme here is control and it is the major benefit of the do it yourself approach. But, added control doesn’t mean it is right for everyone. Risks of this approach include:
- Limited access to institutional quality assets
- 100% responsibility for all of the property’s capital needs
- 100% responsibility for the property’s day to day operations – a significant time commitment
- Small scale does not allow for preferred pricing on vendor contracts like insurance and property management
- Limited reach within the real estate industry can make it difficult to find the best properties and tenants
The time commitment alone can make the do it yourself approach a non-starter for many individual investors. When compounded by the required operational expertise and industry contacts, it can be a recipe for adverse outcomes. For this reason, it can be a good idea for individual investors seeking passive income to outsource these efforts to a professional real estate investment company or private equity firm.
Outsourced Approach – Risks and Benefits
For an individual investor looking for exposure to commercial real estate investments, outsourcing key activities to a professional investment manager can be a good idea for the following reasons:
- It is their core business. Real estate investment managers spend all day, every day, looking at properties and analyzing them on behalf of their investors. Their core competencies involve all of the skills necessary to make a good investment decision.
- Efficiency. Professional management firms have honed their craft over dozens or hundreds of transactions so they have streamlined their operations to ensure the best chance for a desirable outcome.
- Leverage. By investing alongside a professional management firm, investors are able to leverage their network of tenants, brokers, and bankers to get access to the best opportunities.
- Quality. Working with professional management firms allows an individual investor to obtain fractional ownership of an institutional quality asset that they could not likely afford on their own.
- Time. Perhaps the biggest benefit is simply the time that is gained by outsourcing property identification and management activities to a third party. This allows individual investors to focus their time on the things they enjoy the most.
But, there are risks to this approach also. They include:
- Liquidity. Professional managers often require their investors to commit their capital for a period of 5-10 years or longer. During this time, the investment is not liquid.
- Fees. Professional managers do not work for free. They charge management fees that can affect the investment’s bottom line.
- Experience. The experience of a professional manager can vary widely from one to another. Working with an inexperienced one can have adverse outcomes.
For these reasons, it is critically important that individual investors perform a significant amount of due diligence on their potential managers to ensure they are a suitable investment partner.
Interested in Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, 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 are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
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