Passive Investing in Commercial Real Estate - 2020 Part Four of Four

Part Four: Bringing It All Together

So far in this book, we’ve talked about passive investing, business-oriented commercial real estate, the five property types, syndication and sponsors, and deals. Along the way, I’ve given you a glimpse into my investment approach, and the questions you should ask yourself as you go about investing. Remember, passive investing in commercial real estate is aimed at getting you out of any day-to-day hassles of owning property and into the 30,000-foot investment perspective. The key to successful passive commercial real estate investing is selecting the right deal, with the right sponsor, in the right market, for the right price.

Before we wrap up, I want to discuss two important elements of passive investing not mentioned: the market and portfolio diversification. These are the final two elements to consider as you create your investment approach and decide on your portfolio allocations.

Understanding the Market

When I look at any market, be it a town-, city-, state-, or regional-level market, I’m weighing many different factors. Selecting a market to invest in is critical when searching for the right passive commercial real estate investment. Remember, with any deal, you are always buying into the sponsor, the property, and the broader market.

Here are some of the major questions I ask myself when looking at a particular market:

1. How is the overall economy?
2. Is there net migration to or from the region?
3. What is the average household income?
4. What are other investors saying about the region?
5. What are the major businesses and economic drivers in the region?
6. What investments have done well in the past 5, 10, and 15 years?
7. What are the business and economic forecasts for the market?
8. What property types are in demand?
9. What are the business-oriented taxes like?

These questions require a good deal of research – that’s what makes passive investing. Much of your work as an investor is done upfront, weeding out the many bad deals.

A Three-Fold Focus on Diversification

It can be easy for passive investors, especially those who had great early deals, to double down on the same investment type. In the long-run, this can create problems if a region, sponsor, or property type takes a hit in the market. I recommend investors always keep in mind the benefits of diversification. A well-diversified portfolio can smooth out returns year-over-year, especially as some investments tend to fare better than others.

Below are the three primary diversification ‘buckets’ I recommend for passive investors.

• Sponsor
• Geography
• Property Type

Sponsor

It’s good to stick with a winning sponsor, one who is transparent, effective, has a good management team, and structures deals well. They may even have additional deals you can access. It may be tempting to work exclusively with that sponsor. This can work, but what I recommend is you ask that sponsor for additional references to other strong sponsors. Get access to a network of sponsors. This will spread out your risk. Of course, finding a good sponsor may be difficult. Don’t stay married to a lackluster sponsor.

Geography

I often recommend new investors focus on a particular region of the country they understand well. This can be something as general as the Pacific Northwest or Oregon. With that said, make sure to consider a range of different investments throughout the region. Three properties in the same city carry a certain amount of risk if the local economy takes a hit. Make sure you consider local and regional geographic risk.

Property Type

In part two I discussed the five business-oriented commercial real estate property types: industrial, medical, office and work, lofts, and storefronts and retail. Many investors naturally gravitate towards one or two of these property types. This is natural. Just make sure that if you tend towards one or two property types, you are diversified geographically and among sponsors. And remember: certain properties like office space tend to do poorly during economic downturns.

A Word On Equity Crowdfunded Commercial Real Estate

The 2012 Jumpstart Our Business Startups Act (JOBS) Act was a landmark act meant to, among other things, encourage funding in small businesses throughout the United States. A core component of the Act was a provision allowing the purchase and sale of investment securities through crowdfunding. Syndicates and sponsors were the original crowdfunders of commercial real estate. However, it was difficult – or downright impossible – for the average investor to find and invest with a syndicate. Crowdfunding effectively allows many investors to pull funds for commercial real estate, all through an online marketplace. You may have heard of some of these companies, such as Fundrise, CrowdStreet, or RealtyMogul. Online equity crowdfunding has opened the door to many investors – some can invest with as little as $500.

Let me say this: It can be tempting to simply read a prospectus online and invest in a property through these companies. I think this is a mistake for serious investors. Many of these deals cater to your typical investor, and will have a high internal rate of return (IRR) and equity multiple to attract attention. There are much better deals available, and serious investors should be cautious when approaching these deals.

Wrapping Up

My hope with this short primer on business-oriented commercial real estate investing is that you will walk away both excited and full of questions. If you are asking yourself, ‘What’s next?’, I encourage you to reach out to me. I work with current and future commercial real estate investors every day. Good luck!