The Advantages of Co-Investing in Commercial Real Estate

Investing in real estate has long been touted as one of the best ways to create long-term wealth. Some dip their toes into the waters by investing in a single rental property. Others selectively invest in apartment buildings. But few really understand the advantages of investing in commercial real estate – office buildings, retail, hotels, healthcare and senior care, even solar and renewable energy projects. People tend to shy away from commercial real estate because it’s a more complicated asset class. So instead, wary investors often put money into “safer” investment vehicles like stocks and bonds. In doing so, they miss out on a huge opportunity to realize tremendous returns in commercial real estate. In our experience, investing in commercial real estate is a highly attractive fixed income strategy relative to investing in equity markets. When you invest alongside an experienced team, this can be a great risk-adjusted return alternative.

The Benefits of Investing in Commercial Real Estate?

There are several reasons why someone would want to invest in commercial real estate (CRE). And you can do so by investing in either CRE debt or equity. Here are a few reasons to consider:

Passive Income: Residential real estate, such as single family or small multifamily homes, typically produce returns of 1-4% on an annual basis. Compare this to commercial real estate, where returns tend to be upwards of 6-12% per year. CRE has significantly higher income potential than residential real estate. When you invest in CRE debt, you’re guaranteed a stable source of passive income even if the equity investors’ returns fluctuate. You can just sit back and collect your monthly interest check each month, perhaps with an additional lump sum if the loan is paid off or the property is sold.
High Appreciation: Historically, CRE appreciates faster than other investment classes. This is particularly true when investing in value-add opportunities, where there’s room to make improvements that greatly enhance the property’s value and leaseability. Now, if you invest in CRE debt, you won’t realize the benefits of appreciation. Conversely, if the property loses value, you typically have 25% protection before realizing any losses because someone else (the equity investor) absorbs the losses first.
Longer Lease Terms: Unlike residential real estate, where tenants tend to turn over on an annual basis, CRE leases tend to run much longer – typically, five years at a minimum. Depending on the tenant or asset class, leases could be 10, 20, 30-years or more. Investors can also hedge their risk by investing in multi-occupancy properties where the cash flow from having multiple tenants offsets the risk with any one tenant unexpectedly leaving.
Lower Expenses: CRE tenants often sign what are known as “triple net” (NNN) leases. This means that, in addition to paying their base rents, they also pay all net taxes, net building expenses, and net common area maintenance fees. These costs typically fall on the building owner when investing in residential real estate.
Tax Benefits: Real estate is one of the most tax advantageous asset classes. The two biggest benefits are the mortgage interest deduction and depreciation. CRE tends to have high mortgage expenses, and therefore a high annual deduction. And all CRE investments can be depreciated over a 39-year period (or faster, with accelerated depreciation).
Leverage: Although most investors place debt on their CRE investments, they build up equity in short order. Investors can tap this equity to make future investments. Leveraging allows real estate investors to realize a higher return on investment than buying an asset outright.

The Benefits to Co-Investing with Institutional Investors

Given CRE’s complexities, few people make the leap to investing in the asset class directly. That’s why co-investing with institutional investors can make a lot of sense. Here are a few advantages to this approach.

Access to Opportunities

Institutional investors often have information that is not available to the general public. They have teams of people working to find, analyze and underwrite deals with a level of sophistication that the average investor would struggle to grasp. By co-investing with institutional investors, a person can leave the due diligence to a trusted partner who specializes in CRE investing for a living.

Overcome High Barriers to Entry

CRE has high barriers to entry. As we noted above, most banks want you to put down at least 25% when buying a CRE asset. Few people can put that much equity into a single deal. Instead, co-investing with institutional investors allows a person to put in just a fraction of the equity while still realizing the full spectrum of benefits. Increasingly, there are even opportunities for people to co-invest in CRE debt alongside institutional investors (more on that to come).

Preferential Debt

Institutional investors often have long-standing relationships with banks, pension funds, life insurance companies and others who can provide low-cost debt that is not available to the average investor. And most institutional investors have credit standards that are on par or exceed the standards of typical money center banks. Therefore, co-investing opens doors to preferential, high-quality debt that makes the project’s overall returns that much more lucrative.

Management Expertise

Experienced institutional investors understand the management and operational complexities of CRE. By co-investing with institutional investors, a person can invest in a deal and then let the institutional investor drive the process. Now, this isn’t to say people should invest blindly. All investors are still encouraged to do their homework before investing.

CRE Investing: Which Strategy is Right for You?

There are certainly advantages to active investing in CRE – more control over the process, deal flow, contractor selection and the like. And there are benefits to passively investing in CRE by partnering with an institutional investor, as outlined above. So how do you determine which path is best for you?

Here are a few things to consider:

How much time do you have? Active CRE investing is incredibly time intensive. Partnering with an institutional investor is a fixed-income strategy that allows you to take a hands-off approach. What are the potential returns? Co-investing with an institutional investor could open doors to deals that generate significantly larger returns than if you were to invest in CRE on your own. What level of effort is needed? With the right team in place, active investing in CRE might not require a lot of time. For instance, a skilled property manager can oversee most of the day-to-day operations and maintenance at a property. However, when effort IS required by the investor, the effort that’s needed is typically a heavy lift – like negotiating the terms of an agreement or obtaining necessary permits and easements for renovation projects. Institutional investors are better equipped to deal with tasks such as these. What are the current market conditions? CRE is a highly illiquid asset class. If you invest in the wrong type of project at the wrong time, your investment could go belly-up. Co-investing with an institutional investor brings a level of sophistication and expertise to a deal that considers multiple tangential factors that could influence the success of a deal. Who are your partners? If you are going to co-invest with an institutional investor, it’s important to understand your partners’ skillsets. Here at AVANA Capital, for example, we specialize in co-investing on the debt side in the following sectors: hospitality, solar and renewable energy, healthcare and senior care. We are very strategic in our approach. For instance, we like hospitality because historically, dips in travel and tourism tend to be short-lived. Meanwhile, solar and renewable energy are growing exponentially, and investors benefit from state and federal tax credits. And given the aging U.S. population, we see healthcare and senior care as another frontier for CRE debt fund investments. Institutional investors who partner with us understand our expertise and our strategy in debt funding, and we in turn understand their motivations before deciding to co-invest alongside them. Investing in CRE and more specifically debt fund CRE’s isn’t for everyone. But if it sounds like something you might be interested in, contact us today. We’d be happy to discuss multiple opportunities to co-invest with our team of institutional investors.