Key Points
- Private commercial real estate (CRE) investing offers a diverse range of property types and investment theses.
- Private-market CRE investing allows for passive investing without the hassle of managing tenants and properties.
- The four main types of CRE investments are Multifamily, Office, Retail, and Industrial.
- Investors can participate in CRE investments at different levels in the capital stack, each offering different risk and return potential.
- The risk/return profile of a CRE investment is determined by the investment style, such as Core, Core Plus, Value Add, or Opportunistic.
- Investors should consider their risk tolerance, time horizon, liquidity needs, and the track record and focus of the CRE investing platform and sponsor when evaluating CRE investment opportunities.
- Common return metrics for evaluating CRE investments include Internal Rate of Return (IRR), Equity Multiple, Cash-on-Cash Return (CoC), and Cap Rate.
A CRE Investing Primer
Real estate investing can take many forms, including buying rental properties or investing in real estate investment trusts (REITs). However, commercial real estate (CRE) offers a more diverse range of investment opportunities. With the rise of fintech-enabled investing, private-market CRE has become more accessible to individual investors. Private-market CRE investing allows for passive investing without the hassle of managing properties and tenants. This article provides an introduction to private-market CRE investing for individual investors.
What Is CRE Investing?
CRE investing involves real estate transactions undertaken by professional investors. The term “commercial” can refer to multi-tenant properties, including multifamily. CRE transactions are typically more complex and involve multiple parties. The returns from CRE investments come from rent and appreciation, making it a potentially lucrative asset class. The passage of the JOBS Act in 2012 opened up CRE investing to individual investors through various platforms that connect them with real estate investment firms. This has significantly expanded access to private-market CRE investing over the past decade.
Common Types of CRE Investments
The main sectors of CRE are Multifamily, Office, Retail, and Industrial. There are also niche sectors, such as lodging, self-storage, and data centers. The lines between CRE property types may blur, and new sub-asset classes may emerge as real estate operators innovate and tenant demands evolve. Multifamily properties tend to dominate online CRE investing platforms due to their straightforward investment thesis and essential function. CRE transactions involve both debt and equity, and there may be a middle layer of financing in the form of subordinated debt or preferred equity. CRE investors can participate anywhere in the capital stack, with common equity positions being the most prevalent. The risk and return potential of a CRE investment depend on its position in the capital stack.
How to Evaluate CRE Investment Opportunities
There are four main investment styles in CRE: Core, Core Plus, Value Add, and Opportunistic. Core properties are stabilized and generate steady cash flow, making them the least risky. Core Plus properties are near-stabilization and require some capital expenditure to increase occupancy and rental rates. Value Add properties have the potential for significant value appreciation through upgrades and re-leasing. Opportunistic properties involve higher risk and are often associated with ground-up development or complete repositioning. When evaluating CRE investment opportunities, investors need to consider their risk tolerance, time horizon, liquidity needs, and the track record and focus of the CRE investing platform and sponsor.
How to Find the Right Real Estate Investment
Since the JOBS Act, there has been a proliferation of CRE investment platforms. To select the right investment, investors need to consider their risk tolerance, time horizon, liquidity needs, and the track record and focus of the platform and sponsor. Diversification is key in CRE investing, and the low minimums offered by online platforms make it easier for investors to diversify across different platforms, operators, property types, markets, and risk/return profiles.
Appendix: Glossary of Terms
When evaluating CRE investments, there are several key metrics to consider:
- Internal Rate of Return (IRR): The IRR represents the discount rate that makes the net present value of all cash flows equal to zero. A higher IRR indicates a better investment.
- Equity Multiple: The equity multiple is the total profit plus equity invested divided by equity invested. It is a measure of total return.
- Cash-on-Cash Return (CoC): The CoC return is the annual pre-tax cash flow divided by equity invested. It is a key metric for cash-flow-focused investors.
- Capitalization Rate (Cap Rate): The cap rate is the net operating income divided by the purchase price or current market value of a property. It reflects the expected return on an unlevered basis.
- Loan-to-Value (LTV): The LTV ratio is the ratio of debt to the total value of the real estate asset. Higher LTV indicates higher potential return but also higher risk.
These metrics can help investors evaluate the potential return and risk of a CRE investment.
