What Investments are BEST?
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As 2022 commences…with four seasons ahead, a NCAA college football champion to be crowned tomorrow – go Georgia – mid-term elections, and a few resolutions still in tact – I thought it would be revealing to discuss the various ways folks invest in commercial real estate.
Recently, I had this conversation with a friend and client of mine. He’s certainly not a novice as he’s owned commercial real estate. The subtle difference, however, is he’s owned it to house one of his operating companies. Some would refer to this as an owner-occupant. Sure, the commercial real estate is an investment, but the tenant – in an investor owned business.
But on this day, his wife and I reviewed the various genres and my recommendations for their portfolio. I should also mention, their need to deploy money into an income property was triggered by the sale of another income property. Therefore, we will be utilizing a tax deferred exchange – AKA a 1031.
Currently, their holding is a special purpose building in town – one the family has owned for decades. Typical in this scenario – the neighbor approached them on their willingness to sell. Usually met with a no, this go around the answer was yes. A contract was drawn and closing is scheduled mid-month.
During our lunch meeting – after all the grandkid stories were exhausted – his question was simple. If this were your money, how would you invest it? Here’s what I shared with them.
You’ll first need to determine your comfort level with risk. Next, determine how actively you’ll manage your acquisition. Finally, what is your exit?
Let’s start with risk. Generally, the riskier a stake in real estate – the higher the return – in our parlance, a capitalization or cap-rate. Consequently, a twenty year industrial lease with Amazon as the occupant should yield less than a Petco store with a 2023 expiring lease. Why? Because the rent Petco pays may be interrupted next year. They may bolt! You’ll then have to originate a new lease with all the appurtenant costs of down-time, brokerage commissions, rent concessions and the like. Some investors may find favor. If the Petco can be bought at a discount, costs of a new lease covered, the rewards can be great. Other, more risk adverse buyers would prefer the lower “guaranteed” return a long-term lease affords.
How you’ll collect the rent – or the level of your involvement – is your next consideration. Generally, a retail strip or incubator industrial property will sport multiple tenants with varying lease expirations, credit worthiness, and drama. Sorry. Can’t pay you this month because one of our customers stiffed us. For a percentage of the rent check, a property manager can be employed. You then avoid the calls on Saturday with a leaking toilet. But. The luxury of a middleman depletes your check at the end of the month. Single tenant assets, like our Amazon example, have virtually no management. In fact, if the lease is Triple Net in nature, you simply collect each month – no management necessary.
Finally, let’s consider your exit. You see, pouring money into commercial real estate is not like buying a stock, bonds, precious metals, or art. Sure. Risks abound with any gamble. The difference is the liquidity. If you buy a share of General Motors and decide to sell it – buyers are plentiful and stock markets prevail. Commercial real estate is a bit trickier. Imagine selling in 2009. Yikes! Therefore, how you’ll depart the investment must be weighed. Some like to buy, put the token on the shelf, and allow their grandkids to decide what to do years from now. Others prefer to create value and bail. Certain types of buildings lend themselves to value addition. Take office buildings as an example. With our pandemic fueled uncertainty with office suites, some may be drawn to the higher returns an investment in office may allow. Fill it with good paying long term tenants and sell it. Love it or list it, indeed.
Our guy prefers a lower risk, little management and plans to hold long-term. Therefore, at the end of our discussion – we decided to focus our search on a single tenant industrial building with a mid-length lease of 3-5 years. Our expectation is a return in the 4% range.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at firstname.lastname@example.org or 714.564.7104. His website is allencbuchanan.blogspot.com.