The Private Investment Pool
Commercial real estate pros help today's investors dive into this growing market.
year, national and local private investors purchased more than $60
billion of commercial real estate through November, accounting for more
than half of all commercial real estate investment, according to Real
Capital Analytics. This makes working with private investors a
lucrative choice for commercial real estate professionals.
investment in commercial real estate is not a new phenomenon, but the
number of first-time investors and the amount of capital they bring to
the market are increasing dramatically. Why? Recent economic conditions
have made real estate an attractive investment.
the collapse of the stock market in the recent past, [private
investors] are looking at real estate as a safe-harbor investment,”
says H. Dean Weitenhagen, CCIM, of Grubb & Ellis Mid-America
Pacific in West Des Moines, Iowa. “Some who had real estate in their
investment portfolio in the past were reawakened to its benefits after
the market debacle.”
Wariness about the stock
market isn't the only lure. “The low interest rate environment has
brought real estate to the attention of more private investors,” says
Todd A. Kamps, CCIM, vice president of brokerage at Colburn Hundley in
Grand Rapids, Mich.
Not surprisingly, a majority
of today's private investors are new to the industry. “Private
investment used to be owner/operators or industry money, but now it's
not necessarily those with real estate backgrounds sponsoring
investments,” says Tim Strange, CCIM, SIOR, a senior adviser with
Sperry Van Ness in Oklahoma City .
Ackerman, CCIM, SIOR, executive vice president of CB Richard Ellis in
Pittsburgh, agrees. “What is unique about private investors is that
they are not necessarily in real estate full time and, in many
instances, have day jobs that are totally unrelated to real estate,” he
With so many private investors crowding
the market, gaining them as clients seems like it should be easy. But,
as with other commercial real estate transactions, brokers should do
their homework before wading into this sector. Successfully working
with private investors requires knowing who they are, what they want,
and how to overcome their unique challenges.
The Economy Enigma
cheap loans continue to attract private investors to commercial real
estate assets, but what will happen if interest rates rise or the
Although such scenarios may
tempt investors to put money back into the stock market, few commercial
real estate professionals predict this happening to any great extent.
“In the short term, higher interest rates may slow the flow of capital
into real estate, but long term they should not have any major impact
since real estate has performed well over the long term. In fact, for
private investors, real estate has become the mainstream asset class in
their portfolios compared to stocks and bonds,” Ackerman says.
cite other ways, both positive and negative, that changing economic
conditions might affect the private real estate investment market.
the positive side, an improving economy may draw institutions back to
primary cities, leaving more properties for private investors in
secondary markets, says Jonathan M. Hardy, CCIM, a vice president at
Coldwell Banker Commercial in Indianapolis . Institutions currently are
diversifying into strong secondary markets such as his, “running up
pricing and thereby eroding returns that private investors would
receive if they paid the same price,” he says.
addition, rising interest rates will bring the price/value balance back
to equilibrium. Due to inexpensive loans and scarce quality investment
properties, many investors are overpaying for buildings. Higher
interest rates should correct this problem. However, this benefit has a
downside. “On the one hand, investors will be happy that prices will
come down as a result of higher interest rates. But on the other hand,
people who purchased real estate one or two years ago with a low
interest rate locked for one to three years will find that their
returns have eroded, and perhaps some may be upside down,” says A.
Nicholas Coppola, CCIM, president of Coppola Properties in Needham,
Mass. Investors with balloon payments or variable-rate loans are most
at risk of losing money.
Yet measures can be
taken to combat potential loan problems. For instance, Coppola insists
that his clients secure long-term financing with a 10-year fixed note
at a minimum. “Most of my investors understand that with interest rates
at or near historic lows there is only one direction they will go from
here. Better to be locked in for a longer period than to be faced with
a rate increase after three or five years and risk losing precious cash
flow to a higher debt payment,” he says.
prevent future mortgage defaults, some Southern California lenders are
requiring high debt coverage ratios. As a result, investors are
required to make down payments in the 35 percent to 45 percent range,
says Robert V. Vallera, CCIM, a senior vice president with GVA IPC
Commercial in La Jolla, Calif. “This should provide some margin of
protection against widespread mortgage defaults if interest rates rise
a few hundred basis points,” he says.
improving economy benefits multifamily property owners in a unique way:
Rising rates may halt the home-buying surge, says Jackson Cooper, CCIM,
a Sperry Van Ness adviser in Boise , Idaho . Thus, multifamily
occupancy rates will rise, allowing owners to increase rents.
Today's Private Investors
number of private investors continues to increase as stock market
instability persists and more people become familiar with real estate
as an investment. “Investors desire to create stability in cash flow
both long term and short term, so they are dumping their money in real
estate,” Cooper says.
Today's typical private
investors fall into two categories: experienced real estate investors
and young investors entering the market for the first time. Veteran
investors have learned from past experiences in volatile real estate
markets and are savvier and more informed than they've ever been. Many
have been successful and are pumping even more money into their real
estate investment portfolios. “Private investors have become less risk
averse and have actually become less leveraged because they have built
up so much equity in their portfolios,” Ackerman says.
example, San Diego County, Calif., apartment values have tripled during
the past eight years, “which means that a 25 percent down payment in
1996 has appreciated 12 times in value, not even considering the cash
flow,” Vallera says. “My clients used to scramble to put together down
payments of a few hundred thousand dollars. Now some of them are
writing earnest money checks of that size.”
the other side, novice investors also are flooding the market. Raised
in the Internet era, these first-time real estate investors are tech
savvy, willing to diversify beyond their markets, and aggressive in
pricing. “These new investors present a challenge for the seasoned
private investors,” Coppola says.
today's private investors form small syndicates (typically limited
liability companies to avoid personal liability in the event of a
lawsuit) to purchase real estate properties. Family trusts are another
large percentage of the private real estate investment market. “The
accumulation of wealth has increased dramatically and is filtering into
the private sector,” says Daniel S. Martin, CCIM, CPM, a senior
investment adviser with Sperry Van Ness in Arlington Heights, Ill., who
is seeing more clients invest inheritance money in real estate.
plans are a relatively new source of investment capital. People who
previously invested in securities now are looking at real estate, says
William Hugron, CCIM, managing director of the Charles Dunn Co. in
Huntington Beach , Calif. “Many people are taking their [investment
retirement accounts] and putting the capital into self directed
companies and investing in real estate. This will be a great source of
business for the real estate broker,” he says.
What Do They Want?
portfolio size, their familiarity with real estate investment, and
their investment goals determine what property types they seek.
private investors are not looking for fast cash; they prefer
investments offering long-term, stable cash flow and equity. “One
factor that distinguishes private investors from institutional
investors is that private investors are investing their own money where
every dollar in increased sale price actually goes into their own
pocket. For this reason two motivations emerge: maximizing the price
and protecting their investment,” Ackerman says. “Many of them are
looking to build an investment portfolio for their retirement.”
buildings are many private investors' first choice because of the
comfort factor: Most people have rented an apartment at some time in
their lives, so they are familiar with the property type, Martin
Single-tenant, triple-net retail is
another top pick. With such properties, private investors prefer trophy
tenants, not trophy buildings. However, “Reliance upon a single tenant
contains an element of risk that can be balanced within a sizable
portfolio,” Vallera says. “Few young investors have large enough
portfolios to balance this risk or accept the lower capitalization
rates normally associated with single-tenant triple-net or trophy
Yet multitenant triple-net
properties require little, if any, hands-on management, which many
private investors prefer. “The less that someone has been involved in
real estate before the more likely they will want an easy-to-manage,
triple-net-type property,” says Karl N. Innanen, CCIM, a vice president
with Colliers International in Kitchener, Ontario.
desire for less management is prompting many older investors to trade
their multifamily buildings for triple-net retail or office, “which,
depending on where you buy, can generate good cash flow without the
significant management issues of owning apartment properties,” says
David J. Buurma, CCIM, vice president of BT Commercial Real Estate NAI
in Napa, Calif.
Across the country, commercial
real estate professionals are experiencing little demand for
rehabilitation deals because most private investors don't have the
experience to undertake such projects. The one exception is properties
that are extremely undervalued and can be flipped quickly. “Investors
in the wealth-building phase of their careers are frequently more apt
to pursue value-added investments such as rehabs or otherwise
underperforming properties,” Vallera says.
Overcoming the Challenges
investment brokerage can be lucrative: Clients are plentiful, money
still is relatively cheap, and the Internet allows brokers to cast a
wide net. However, these advantages also present several challenges.
Little Available Product.
The No. 1 problem is finding quality, well-priced product, investment
pros say. “More people are hearing that their uncle or friend or
neighbor has made a score buying real estate [so] they are jumping into
the real estate arena,” Coppola says. “These new investors are making
it difficult for senior or more sophisticated individual investors to
locate deals because they are not willing to take the risks or overpay
just to compete with novice investors.”
available land for new construction also contributes to this problem in
some regions. For instance, Curtis A. Skomp, CCIM, a broker with
Coldwell Banker Schmitt Real Estate in Key West , Fla. , experiences
this conundrum on a daily basis. “We are totally built out on our
four-by-two-mile island,” he says.
properties for clients, brokers should stay in touch with all owners,
especially those who currently aren't interested in selling, rather
than only focusing on for-sale properties. Innanen lives by the 80/20
rule: Of 100 probable properties, 20 are listed, “and those are the
ones that are being fought over by the buyers, while the other 80 may
be ripe for the picking. So I have tended to concentrate on the
unlisted properties,” he says.
It helps to
develop a regular prospecting model, Cooper says. “Contact owners on a
consistent basis to keep in their faces when they do decide to sell,”
he advises. Skomp maintains relationships with the owners of prime
commercial real estate in the Florida Keys; he then tries to match
qualified buyers with available properties, whether for sale or not.
don't forget the basics: cold-calling current property owners,
networking, holding seminars, and maintaining relationships with
related- industry professionals. “If you wait on good triple-net
properties to show up on your doorstep, you'll be waiting a long time
with resulting empty pockets,” Weitenhagen says.
Investors with unrealistic expectations are another hurdle. For
example, in California Buurma has encountered many investors who want
to sink earnings from their businesses into real estate “without a
thorough understanding of what drives a specific market and/or product
type,” he says.
Qualifying investors up front is
one way to combat this problem. Determine their motivations and make
sure they are capable of real estate investment. Buurma won't work with
clients until he has established three things: The investor is well
qualified, is willing to be educated about the market and property
types, and is willing to act quickly when presented with a property
that meets the agreed-upon criteria. If investors don't act on your
recommendations, they should drop in priority, and you should offer
more-active and realistic buyers the best properties first, Innanen
If a prospective client refuses to be
swayed from his unrealistic expectations, the best bet is to walk away,
even if it means losing a potential commission. “If they're not willing
to accept reality, cut them loose and save yourself a lot of grief,”
Competing With the Internet.
Although it allows you to market your properties and services to a
large audience, the Internet also competes for your business: Why
should investors consult you when they can find property and market
information free online?
Private real estate
investment used to be a local and relationship-driven business.
However, “the conventional barriers that prevented information sharing
are gone, and investors can find opportunities by sitting at their
computers rather than driving around their local market looking for
properties to purchase,” Ackerman says.
can be a bonus: “Most sales to private investors are not currently
clients of our firm and are spur-of-the-moment buyers,” Ackerman says.
“We are finding that approximately 30 percent of our sales of
investment property are to private investors from the West Coast, which
was almost unheard of 10 years ago.”
Internet can't compete with a broker's expertise. Brokers offer
valuable insight and can add context to the numbers presented on Web
sites. They can “truly balance the risk/price with the individual
investor's modus operandi,” Weitenhagen says. Ackerman agrees: “A
professional CCIM can provide private investors much-needed
underwriting expertise and local market intelligence that is not
available on the Internet.”
investment brokers agree on the continued strength of the private
investment market. “People are having good experiences,” Strange says.
estate's tangibility is an important aspect of its attraction.
“Investors who don't like the low returns of bonds or the volatility of
the stock market or lack confidence in Wall Street can buy real estate,
which they can touch and feel as well as effect change to add value,”
However, as always the economy
is the wild card. Although investment brokers don't expect rising rates
to negatively affect private real estate investment, a changing economy
could have repercussions. “The big unknown that is lurking in the
shadows of our current economy is that so many investors have been
willing to pay a premium for properties over the past several years
because financing has been so available and rates so low,” Buurma says.
“With so many people purchasing highly leveraged investments with low
variable rate loans, it remains to be seen what impact higher interest
rates will have on the financial viability of these properties. It
could get interesting.”