Asset types

How to Find a Commercial Real Estate Deal

The best ways to find solid commercial real estate deals are through:


* Crowdfunding


* Private placements


* REITs

In this article we shortly describe these deal sources.

Crowdfunding

Real estate crowdfunding is a fairly new concept gaining popularity among individual investors looking mainly to diversify existing stock portfolios with more a stable asset type: real estate. Real estate crowdfunding platforms provide investors with the opportunity to select each property they want to invest in on individual bases, providing an alternative to standard fund investing. Also, investing in crowdfunding allows investors to be more selective and build a portfolio that is more aligned with specific individual investment goals.

Crowdfunding platforms opened up new opportunities for investors in markets previously off limits, such as commercial real estate. Crowdfunds collect the money from a pool of individual investors in order to contribute to a specific investment. The money is only paid down for an investment if there are enough funds collected; otherwise the investment is cancelled, and you should receive your money back.

You should only be willing to go for a crowdfunding source of investment if you are willing to put in the time and effort necessary to properly review and assess the deal including property, market, partner, investment documents etc. For those looking for even more passive solutions for real estate investing, REITs are a great choice.

Subsequent to the market crash of 2007, as new regulations were implemented and debt financing became harder to arrange, many investment projects and startup businesses were left without funding. In 2012, in order to support business growth activity, the Jumpstart Our Business Startups Act (JOBS Act) was introduced which broadened the scope of who can invest in startups.

While new legislation was created with startups in mind, it gave all interested parties the understanding that new rules can be implemented into the real estate industry, making the market more accessible to individuals marketing shares of investment projects to individual investors. After that point, individual investors gained access to projects previously accessible only to institutions and ultra-wealthy individuals, significantly reducing the barriers to entering into the commercial real estate market.

Early real estate crowdfunding platforms were Fundrise, Realty Mogul and Patch of Land. Since then dozens of new platforms emerge each year. Some of them fail and some of them manage to exceed expectations and only grow in size. In 2012 only $19 million was raised in crowdfunded deals, but today the crowdfunding market size is $5.5 billion. And the World Bank predicts that the total size of crowdfunding deals will increase to $93 billion by 2025.

When you invest in a deal through a real estate crowdfunding platform, you become a limited partner in a project. Thus, you need to evaluate all aspects of the project before entering the deal. Some projects are debt-based: You will be investing in a third-party mortgage tied to the underlying real estate investment and will receive a fixed percentage of the mortgage interest payments.

Some projects are equity-based, where the money you contribute will be used as an equity contribution to a specific project. Many platforms have a minimum requirement of only $5,000. Some of the fees are collected upfront and some are deducted from your returns and reach to 3% of an investment’s value.

Private Placements

Private placement investments, also called non-public offerings, in commercial real estate are usually offered through a Limited Partnership (LP) as well as individual investments or funds which are managed by a professional real estate investment company. LP usually consists of a sponsor who creates an entity designed to arrange a limited liability for the investors. Often LLC (Limited Liability Company) is used as a vehicle for investment instead of LP, which is used to purchase and manage a property.

A created management company releases the burden of property management from investors. So, you as an investor do not participate in the day-to-day management of an investment. However, you do oversee the investment management process and have the right to participate in major property-related decisions. A sponsor, however, charges different types of fees for their management services, including an acquisition fee, asset management fees, and profit-sharing from the investment. The split in profits prevents conflicts of interest between a sponsor and investors.

Private placements have more flexibility regarding asset diversification than REITs for example. Private placement investments also offer higher flexibility for structuring investments. There are virtually no limitations on how a sponsor and investors would structure a deal which allows for the most profitable solution for both parties.

Projects offered through private placements are illiquid and subject to many potential investment risks due to the fact that the capital is locked into the investment until the exit date. You as an investor in a private placement may not receive dividends in periods when the market is down or during financial loss.

In addition to incomparably attractive returns, private real estate deals also offer other benefits that include the ability to defer and shelter a portion of income via depreciation deductions and use of 1031 Exchange for the deferral of capital gains taxes. The benefits of private placement deals draw many private investors to the field. However, there are restrictions on participation related to financial qualifications and wealth of the participants in these partnerships. Private placements are not required to register their shares with the SEC, but there is a requirement that the securities are only sold to investors that qualify as accredited investors.

REITs

A REIT, or a Real Estate Investment Trust, is a company that buys, owns and manages income-producing real estate. Shares of REITs are publicly traded. Real estate investment trusts are available in two primary types: Equity REITs and Mortgage REITs. 

Equity REITs invest in the ownership of various property investments while Mortgage REITs provide debt financing for the property market. Hybrid REITs also exist and utilize strategies of both an equity type of REIT and mortgage type. There is a high level of property type specialization in the REIT industry. REITs focus on their individual niches and thus are categorized by apartment REITs, retail REITs, hotel REITs, industrial REITs, office REITs, health care REITs and so on. REITs allow a high level of diversification between asset types as investors see fit.  

U.S. REITs were established by Congress in 1960 to open the investment-grade real estate market to all investors, especially small investors, while creating more liquidity to the investment funds themselves. Legislation introduced in 1960 allowed for creating a new approach which would combine the best attributes of both the stock market and the real estate market.

Since then 35 countries have followed the example set by the U.S. to make the real estate market public. With REITs the benefits of the commercial real estate market became available to all individual investors despite their wealth status. The REITs’ approach to investing has improved over the years. Today the REIT industry has grown to above $1 trillion in market capitalization with approximately $3 trillion in gross real estate market management.

REITs provide investors with an opportunity for stable and meaningful dividends, portfolio diversification, liquidity, and competitive performance on a regular basis. In addition, REITs provide a solid level of transparency to real estate investors, which is rare in this industry. Investors looking for a steady yield should go for REITs as a primary source of real estate deals. REITs are obligated to pay out 90% of their earnings in dividends to investors on a regular basis in order to maintain their tax-free status.