Advancing In The World of CRE Investing

Commercial assets held through advanced CRE investment strategies are still some of the most lucrative on the market despite periods of turmoil. Almost 90% of investors surveyed by Deloite expect their company revenue to increase in the near term and beyond as the global economy continues to grow. 

Even so, seasoned commercial real estate investors who are well beyond the basics of investing need to look beyond fundamental investment practices to maximize their returns. This article dives into some more advanced strategies that seasoned investors can use to generate stable returns.   

CRE investment strategies overview

Commercial real estate investing involves buying, selling, holding, leasing, and managing commercial properties for profit. An investor’s approach is typically dependent on the kind of asset they purchase. 

There are four main investment strategies used by commercial real estate investors. There is the traditional “buy and hold” method, also known as Core investing. There is Core+ investing, where investors perform a few renovations on an asset they plan to hold for the long term. Value-add investors focus on buying and rehabbing distressed assets. Opportunistic investors buy a vacant plot of land and then build a new building. 

Active vs. Passive management strategies

Commercial properties are usually actively or passively managed by investors. Advanced investors can still utilize these strategies, although the means can be more complicated. 

Active investment strategies require an investor to spend time managing a building’s day-to-day operations. This can include scheduling maintenance, negotiating leases, and prospecting new tenants. 

Passive investment strategies are for investors who don’t have a lot of capital and don’t want to be involved in day-to-day management. That means they will likely pool their funds into a Real Estate Investment Trust, a Real Estate Investment Group, or a crowdfunding opportunity and expect a reliable dividend payment. 

Co-Investment strategies with private equity

Co-investing with a private equity firm is one strategy many advanced CRE investors employ. In this setup, the PE firm acts as the deal sponsor, and at least one or two other investors act as limited partners. Together, the team participates in the equity financing of a particular asset. This approach increases an investor’s exposure to a specific asset, thereby increasing their potential profits through these types of channels.

A critical issue that all co-investors need to agree on before purchasing a building is their exit strategy. Typically, co-investors will look to exit an investment simultaneously. That may only sometimes be the case, and co-investors must be on the same page regarding their exit to maximize their returns. 

Diversification and portfolio management

There are a couple of ways to think about diversification as portfolio management. First, there’s diversification at the asset level. That means a multifamily investor may consider buying into a retail, industrial, or office asset to balance their portfolio. Then, there is diversification at the strategy level. That could involve a Core+ investor getting into a Value-Add or Opportunistic deal. This strategy could also include buying into a REIT or crowdfunded property. 

Leveraging technology and data analytics

Artificial intelligence, machine learning, and big data are a few tools investors use to spot new opportunities, and they have fundamentally altered investor decision-making and risk management. 

Technology and data analytics can help investors spot new market trends with precision. For instance, AI can analyze vast amounts of demographic data, historical market performance figures, and economic indicators to identify an emerging trend. Companies like Zillow have used this technology to power their home value estimates, and the same concept can be used a number of ways for CRE. 

Risk mitigation and exit strategies

Risk mitigation involves conducting thorough due diligence on a property and its submarket. Investors also need to secure financial reserves, either through lending or insurance policies, to mitigate risks associated with commercial property ownership. 

Exit strategies are just as important to consider. They can include selling a property, recapitalizing or refinancing, or adding a new investor to a group. Investors need to have a clear exit strategy for their investment, and be able to measure when an investment reaches an exit point. Doing so can help maximize an investor’s returns and prevent future losses. 

Alternative financing methods

Advanced investors must also consider alternative financing models to ensure they get the right deal at the right price and terms. Here are a couple of examples of alternative financing models. 

Mezzanine financing. Mezzanine loans are a hybrid financing mechanism where investors can receive more money than traditional bank loans with more flexible repayment terms. These loans are typically approved faster than conventional loans, although they often come with higher interest rates. 

Sale-leaseback. This financing mechanism allows property owners to sell their properties to investors and then lease them back. Investors who want to free up cash for other opportunities favor this approach. 

SBA(7) and 504 Loans. SBA(7) and 504 loans offer investors flexible terms and low interest rates, which can benefit investors who struggle to qualify for more traditional CRE financing options. However, the approval process for these loans can be notoriously slow. 

Tax optimization strategies

Commercial property investors enjoy benefits from depreciation, which can lower their overall tax liabilities, as well as more complex strategies that reduce their taxes. Here is a brief overview of some advanced structures. 

Like-Kind Exchanges.  Like-kind exchanges, also known as 1031 exchanges, allow property owners to reap the benefits of selling their property without incurring taxable income. It works like this. A property owner who sells their building and then reinvests the profits into another property of like kind within six months is not required to pay taxes on the proceeds from the sale. Critical timelines apply.

Estate planning. There are also ways to pass down a commercial property to family members without incurring additional taxes. Families inherit buildings at whatever value they were appraised when the property owner dies, allowing them to forego paying capital gains taxes. 

Understanding market cycles and timing

The commercial real estate market typically goes through four phases: recovery, expansion, hypersupply, and recession. Understanding each cycle phase and timing an entrance or exit into a market can help investors identify new opportunities. 

Identifying where a market stands in each cycle phase requires a solid understanding of underlying supply and demand. Markets with less demand and high inventory levels are typically in recovery or recession phases. Those with more demand than inventory can be defined as in the expansion or hyper-supply phases. Each phase comes with challenges, and investors must consider the ramifications of entering or exiting a market during each cycle phase. 

Impact of macroeconomic shifts

Factors like GDP growth, employment levels, consumer spending, and interest rates can all determine whether a commercial property is profitable. 

Generally, asset prices and rental income rise when an economy is healthy. Investors can expect more significant returns when local GDP rates, consumer spending, and employment levels increase. 

Conversely, assets tend to perform worse when economies sour. The coronavirus pandemic provided some exceptions to that rule as industrial assets outperformed other asset classes because of the broader economic shift towards e-commerce. 

FAQ

What is a good ROI for a commercial real estate investment?

The expected returns for a commercial real estate investment depend on the asset type and many economic factors. Average returns for commercial assets generally sit between 8% and 12% annually. 

What real estate strategy makes the most money?

Rental properties generally make investors the most money because investors can benefit from steady cash flow and asset appreciation. 

What is the most profitable commercial real estate?

Properties leased to multiple tenants, such as mixed-use or industrial assets, are generally the most profitable commercial real estate assets. 

What is the most profitable type of real estate investment?

Commercial real estate is considered the most profitable type of investment. It has historically returned more capital to investors than residential real estate. Commercial properties carry longer leases and can be rented by multiple tenants. 

Conclusions/Bottom Line

Developing an advanced commercial real estate investment strategy requires investors to go beyond general CRE investment concepts, and think creatively about how they finance and manage their properties after purchase. There are multiple tax-advantaged ways to purchase real estate, and there are investment vehicles that can reduce the amount of time an investor spends managing their property. Understanding each approach’s different risks and rewards is paramount to protecting an investment and maximizing its return.