Private real estate investments can be made through real estate asset management companies. These companies choose, maintain, and sell properties on behalf of investors, who typically pool their capital into pools called “funds.” Investing with one of these companies could provide access to commercial investment properties suitable for institutional investors. Still, do your homework before deciding which one to work with would be best.
Most real estate managers, when acquiring properties, construct models based on expectations they think can be met. However, the asset manager is ultimately responsible for the multitude of inputs used in the science and art of real estate return projection. Due to this, investors place a high premium on the company’s business strategy, management, performance, and history.
When competing for new clients, asset management companies seem to say the right things. Investors need companies that can stand on their own merits, rather than just bragging about them. Investors should pay attention to what the managers say and consider the team’s size and training in all relevant areas (including acquisitions, asset management, and investor communications) to understand the manager’s competitive advantages better. Does it succeed in luring and keeping top talent? To what extent have key personnel been with the company, and for how long? Check to see if they have the expertise and people to provide the service and execution essential to realizing profits and the kind of return on investment they offer.
This post is the second two-part series in which we discuss the five most frequent blunders real estate asset managers make. When assessing potential investment opportunities, private investors should keep an eye out for these blunders and ensure they’re asking prospective company managers the right questions.
Error #1: Locations were not properly vetted.
Even seasoned property management firms occasionally settle for less-than-ideal locations. They can prioritize stable income from established assets or international gateway locations over ambitious expansion plans. Asset management companies may be making poor decisions in light of the shifting market because they are either unfamiliar with the area, have a vested interest in it emotionally, or are just making decisions based on their gut rather than data.
Population and economic trends can be used in a data-driven process to exclude many viable locations. Residential sales can provide commercial real estate firms with information on promising low-cost areas where they will have an easier time attracting and retaining tenants. Using “boots on the ground” observation should be used in real estate due diligence findings and vendor and supplier feedback. Commuter convenience, proximity to work, and low levels of competition are all indicators of good commercial property investment.
Error #2: A failure to do a thorough underwriting of possible transactions.
The financial industry has the right idea. Underwriting investigates proposals to find flaws, including an overly optimistic cash flow projection or an overvalued property. By following a similar due diligence procedure, a real estate acquisition team may verify the validity of the business plan and the financial assumptions underlying it. Small adjustments in the rent growth forecast can greatly affect the bottom line over the long term. Every forecast an asset manager makes ought to be defendable.
An exhaustive investigation of all available commercial properties is insufficient for a real estate team. Disciplined real estate management firms compile comprehensive databases on all investment properties in a submarket, including information on the properties’ physical characteristics, acquisition costs, tenants, owners, and lenders. It will enrich a competitive market study and help with underwriting estimates for vacancies and cap rates.
Error #3: Not having any patience as a customer.
Dollars don’t like to be parked in the backseat. Cash that sits on the sidelines isn’t being put to good use and may lose some of its tax advantages. If making agreements helps fund the salaries of asset managers, they may urge swift action. The risk for real estate investors is paying too much for a commercial facility and falling behind the market.
Building lasting connections with commercial property owners who may one day become sellers or partners takes time and requires patience on the side of a real estate management company. Having a consistent stream of deals to choose from will help commercial real estate firms to pick and choose. The real estate company’s aims are aligned with their investors when potential conflicts of interest, such as an in-house property management team related to the asset management firm, are removed.
Error #4: Overextending one’s debt or using assets as collateral for other debts.
There is good reason to keep the leverage to a minimum: There is a real danger of losing the property if rental income falls below the amount needed to pay the debt. Given this uncertainty, the real estate partners’ equity and cash flow projections are just as crucial as the upgrades themselves. Investors in commercial real estate who act responsibly avoid default and the restrictions of loan covenants by protecting themselves and their projects from shortfalls.
Even though few real estate partners can close with a cash payment, many fail to pay adequate attention to borrowing costs. They must repay the creditors, and the most vulnerable stockholders are those at the bottom of the capital structure. An appraisal needs to include the cost of capital in terms of interest payments and investment returns to determine if a real estate project will provide a profit commensurate with the risk involved.
Cross-collateralizing assets within the fund is another common debt mistake we see managers make. It occurs when the value of one asset is pledged to secure the repayment of another’s loan, leaving the entire investment portfolio vulnerable to the failure of a single holding. Investors’ exposure to risk increases.
Mistake #5: Neglecting to perform regular evaluations of commercial real estate.
In the case of commercial real estate, investors prefer to avoid keeping their equity in limbo for any longer than necessary, but they are not always prepared to sell. They either wait too long for a specific return or sell too cheaply to generate quick cash. The best action is to disregard the entry date and initial purchase price.
A property management company must monitor the asset’s valuation and projected cash flow. The math is the same as what was calculated (or should have been calculated) when you bought it. The time to sell is when the projected returns fall short of the projected returns from selling and reinvesting the money.
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