Parking Money: Approaching Commercial Real Estate Investment

By: Rob Warmowski, Contributing Writer

If there's a compact, useful way to think of starting investment in nonresidential real estate, it's to begin by defining what the act of investment in this asset class is. Start with a roof: imagine a commercial property and all the activity under its roof. Investment is how anyone may participate in the commerce conducted under the roof in question. 

Commercial activity is generally made up of working people, typically company employees, showing up underneath the roof every working day to create value. In exchange for capital invested to obtain a share of property ownership, the fruits of that commercial activity often appear in the form of rents paid to ownership.

Setting aside the thorny issues of the specific commerce in question – labor relations being chief among the factors that produce commerce and therefore the value that investors participate in – an investor in commercial real estate seeks to place a bet on the outcome of buying an ownership share producing a profit, also known as a return on investment (ROI). 
 
This bet is about getting right the mix of factors that go into commerce: labor (workers), business management (tenant’s executive leadership), property management (landlord or property manager efforts), capital (investors), and government (infrastructure, zoning).  Investment in commercial property is a way to say “I believe this property or portfolio will be home to value generation in the future because these factors are all arranged to add value.”

Homework: Do It All

Evaluating commercial investments is the art and science of identifying what you need to know, then learning it. Not doing your homework is not an option, and you should err on the side of too much information rather than too little. Happily, researching commercial property and its tenants and histories can be a bit more information-rich a proposition than other investments.

A prospectus in a stock or bond, once consumed, tends to stand on its own or not – it lives or dies in your eyes by its pitch. But commercial property investment is both more complex and less liquid. It needs to be treated with greater care. Underwriting, or evaluating, these opportunities ties together enough different factors that it pays to develop a holistic perspective, made from many different points of view. 

Atlanta’s Bill Adams, MBA, CCIM, CRB, heads up a commercial specialty brokerage. He does his homework using the following laundry list: “Talk to government officials, adjacent property owners, real estate brokers, and the property’s tenants, if the property is being actively marketed and you have the current owner’s permission to contact the tenant(s).”  

Adams believes those perspectives are vital. “The government officials will make you aware of zoning, planning, and city service issues,” he says. “The adjacent owners can share their experience of owning a property in that location.  The real estate brokers can tell you about market trends and the tenants will tell you about what they like or don’t like about a property and if they are committed to staying in the property.”  Adams is adamant about one investment truth above all others: “never buy a property on pure emotion or rely on unrealistic income projections.”

Get A Leg Up with a CCIM Institute Resource

Start your self-education on the commercial real estate investment ecosystem by checking out the CCIM Online Glossary. Browsing the glossary is a great way highlight what you need to learn.

Giving Credit Where it’s Due

Investigation of a tenant’s business is inspection of the engine that drives property income in the form of lease payments. A major measure of the health of that engine is the degree of how likely a business is to successfully borrow capital. Creditworthiness is a leading indicator in commercial real estate investment for Camille Renshaw, CEO and Co-Founder of Brokers + Engineers, a net lease specialty shop doing business in New York, San Francisco, and Tampa. Net leasing, where tenants are on the hook for more than rent, presents investment opportunities that are sensitive to tenant credit quality.

Renshaw looks for a deep understanding of the tenant’s credit, which is vital to the sustainability of the property’s income and long-term value.  “An experienced NNN broker advisor can help investors analyze a tenant’s credit rating and the tenant’s stock or company news,” she says, as well as “the tenant’s executive team, store sales, and customer visits, and the company’s P&L with particular attention to cash flow.”

Knowing credit history is one thing, but the future of a tenant’s credit is something else entirely. Under Renshaw, Brokers + Engineers has developed a proprietary pricing model for net leased assets. It’s a way to glimpse the future by “leveraging these tenant credit metrics against what we believe is the largest data set in net lease real estate. It creates predictive pricing five years out and then brings it back to today’s net present value.”

Before the Beginning

While taking a holistic view on an investment means doing more diligence work than is done evaluating stock pitches, a stock-like investment experience is available nonetheless. The commercial investment ecosystem expanded significantly in the 1960s with the introduction of the Real Estate Investment Trust, or REIT. Serving to mimic the stock market by condensing the investment proposition into liquid shares traded on stock markets, REITs have for decades expanded the opportunity for small investors to participate in income-producing real estate, including apartments. 

Because by law the taxable income a REIT makes must be distributed at least 90% to its shareholders, successfully managed REIT portfolios throw off dividends to investors, making them excellent income-generating holdings, such returns often serving as a capital-raising stepping stone for investors getting their feet wet in commercial real estate.

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