There are many ways to put money into commercial real estate. A person who wants to invest for the first time might buy a duplex or small apartment building. Someone else might put money into a small retail strip center with other people. Institutional investors, like insurance companies, endowments, pension funds, and ultra-high-net-worth individuals and families, who have a lot of money to invest, often buy “institutional quality” real estate.
With the rise of real estate crowdfunding, many platforms and sponsors use language that makes it sound like their investors are taking part in deals that are good enough for institutions. Even though that may be true, it is essential to distinguish between the kind of investing that institutional investors do and the kind of investing that “retail” investors can do. Even though the real estate may be the same, these two types of investors may participate differently.
Even though there isn’t a single, agreed-upon definition of “institutional quality” real estate, the term is usually used to describe a big and important property to attract the attention of large national or international investors. Institutional quality real estate is also attractive to foundations, investment banks, hedge funds, and real estate investment trusts (REITs).
High-quality assets in major markets are often a sign of institutional-quality real estate. The concept could be expanded to encompass commercial real estate in secondary markets where the property is of exceptional quality, size, and tenant roster. No matter where it is, institutional-quality real estate is usually priced too high for individual investors or smaller partnerships to buy.
At least, that’s how things were until recently.
Changes to SEC rules made it possible for people to fund commercial real estate deals online through crowdfunding. In practice, this means that individual investors are often asked to invest together in “institutional quality” real estate. Investors are told that this product used to be available only to institutional investors.
The difference is that the assets offered to “retail” investors may be just as good as those offered to institutional investors. However, how the deal is set up for “retail” investors through crowdfunding can differ from what an institutional investor would get.
What makes retail investors different from institutional investors?
At first glance, a “retail” investor might seem like someone who invests in retail properties. After all, it makes perfect sense! But the term is used to describe a certain type of investor in a broader sense. A retail investor buys stocks, bonds, and other assets, usually for their retirement, but not as their primary source of income. Retail investors are not people who do this for a living. Most of the time, they invest through a third party, like a brokerage account or a financial advisor.
In commercial real estate, it’s important to tell the difference between retail and institutional investors. Institutional investors are professional investors who make decisions on behalf of another group of people, like insurance companies, pension funds, university endowments, and so on. In the past, some commercial real estate deals were only available to institutional investors. However, more and more of these opportunities are now also available to retail investors (more on this to come).
Institutional investors have access to projects and information about projects, which is another important difference between individual and institutional investors. Most of the time, institutional investors have access to proprietary databases and professional advisors that give them a lot of information about projects, their markets, and how well they are doing. They also have access to a large number of highly paid lawyers and accountants who not only give them detailed information about deals and their sponsors but also often engage in long negotiations with sponsors to make sure their clients’ best interests are being served.
Pros and Cons of Investing In Small Amounts
There are some good things about being a small investor. These things are:
- Advantage: Smaller investments. Most of the time, retail investors can buy commercial real estate with a lot less money than an institutional investor would need. Institutional investors, for example, may only look at deals where the equity check is tens of millions of dollars or more. Most individual investors don’t have that much cash lying around.
- Advantage: It works with different time frames. Retail investors usually put their money into deals with shorter time horizons, like repayment periods of 1–5 years. This gives small investors the freedom to put their money into projects that help them keep their cash on hand better.
- Advantage: You can put your money into more opportunities. Retail investors can invest in more opportunities because they don’t have to put up as much money. For example, they can put $500 into five different ETFs if they want to. They could put $500 more into five different REITs. They can invest in a broader range of opportunities than institutional investors because they have more freedom.
- Advantage: Diversification is a plus. Since crowdfunding, the minimum investments in private real estate have decreased significantly. Small investors can now put less money into more projects, allowing them to diversify their portfolios in ways that were previously impossible.
- Disadvantage: Higher fees. Most of the time, retail investors pay more in fees than institutional investors. Because institutions usually invest a lot of money at once, they have more negotiating power when they want to lock in lower costs.
- Disadvantage: There are fewer chances to invest in the “best” deals. Institutional investors are the only ones who can take part in some commercial real estate deals. This keeps small investors from getting access to some of the best deals, which are really off-limits to the general public.
- Disadvantage: You have little or no power in negotiations. If a retail investor only puts a small amount of money into a single deal, they can’t use their money to negotiate better terms with a sponsor.
- Disadvantage: Contractual terms. They aren’t as well off as institutional investors because they don’t have access to the same resources. In particular, they don’t have access to professional advisors who provide data and advice and negotiate with sponsors on their clients’ behalf.
Pros and Cons of Institutional Investing
Investing through a company or other group has its pros and cons as well. The following are:
Advantage: You can get the “best” deals. Institutional investors have the most money to spend, which is something everyone knows. When they can, commercial real estate deals that need a large amount of debt or equity will often go to institutional investors first. This means that institutional investors are often the first to know about the best real estate opportunities and sometimes the only ones.
Advantage: Scale. When looking to sell more considerable assets or an extensive portfolio of assets, sellers will go to institutional investors instead of trying to sell each property individually to retail investors. Institutional investors can often get great deals because they have the money to buy in large quantities when opportunities arise.
Advantage: Programmatic relationships are a plus. Since institutional investors have a lot of money, they can attract high-quality sponsors who would rather have a single investor with deep pockets for all of their deals than a bunch of investors across each deal. This usually gives sponsors access to the capital they can use however they want, as long as they meet certain investment criteria. This gives them more freedom, even if the terms are usually better for the investor.
Advantage: Impact is better. Institutional investors can affect the market because of how much they can buy. This is true not only for commercial real estate but also when buying or selling real estate-related ETFs, REITs, or mutual funds. When a big institution buys a lot of shares or a big portfolio of real estate, this sends a message to the market and may change how other people invest in the future.
Disadvantage: They are conservative. Institutional investors usually get their money from fiduciaries, who are very careful with their own institution’s money. Managers of pension funds, insurance companies, and endowments are expected to keep their organizations’ wealth safe first and for the long term. Because of this, when the economy is uncertain, institutional investors often stay away from the markets and stop or at least slow down their investment activities until the future looks clearer. On the one hand, this is good because it protects the underlying capital from too much volatility. On the other hand, it can cause investors to miss good times to invest.
True institutional deals are set up very differently than private deals, even if they involve institutional-quality real estate. This is true in two important ways: first, information is clear and easy to find, and second, the investor can negotiate terms on their behalf.
Institutional Investors
Large organizations like banks, endowments, pension funds, hedge funds, pension funds, and exchange-traded funds (ETFs) that invest on behalf of their members or shareholders are called “institutional investors.” Institutional investors buy and sell stocks, bonds, and commercial real estate, among many other things.
Institutional investors usually have more freedom in how, when, and where they invest. This is because the Securities and Exchange Commission has stricter rules for individual investors. The SEC does this because it thinks institutional investors are smarter and have more resources to protect themselves.
Institutional investors usually put more money into their investments than do individual investors. For example, A life insurance business might only invest in an office building if they can invest at least $30 million. There is a considerable gap in investment quantity and scale between individual investors and institutional investors.
First, in the world of institutional investors, information about deals is spread and available much better. There aren’t that many institutional players, and most are seasoned, very experienced professionals who know each other and do business in part based on their personal reputation.
In the private sector, finding information and resources to double-check a sponsor’s due diligence is much harder. This is because institutional investors have much more money and resources than individual crowdfund investors, which they can use to check assumptions and compare with market norms and expectations.
Second, and just as important, this type of transaction is far more complex than the typical retail investment contract, and the parties involved have a wide range of terms, conditions, rights, and responsibilities. Real estate deals in which the property and all parties involved are institutions demand expensive and experienced lawyers who will battle for their client’s best interests. Shared decision-making and committee management are commonplace for sponsors who invest in institutional properties with institutional investor partners. This is because their equity partners want to decide on the assets to protect their capital.
This can be frustrating for sponsors who would rather have full control over operations. However, the cost of capital is also high, and institutional investors usually look for default clauses that let them take over ownership if sponsors don’t do their jobs. To get around these restrictions and for other reasons, experienced sponsors have turned to high-net-worth investors as an alternative to institutional investors.
Because of these things, investors need to ensure that, even though they can buy institutional-quality real estate, they also get institutional-quality terms.
Because of this difference and the fact that most people are not used to investing in this way, many do not fully understand the benefits of investing in institutional-quality real estate.
Why Investing in Institutional-Quality Real Estate Is a Good Idea
There are both public markets (like REITs and CMBS loans) and private markets where you can invest in institutional-quality real estate (e.g., direct property investments and mortgage loans). Some ways to invest in real estate are through pooled funds, joint ventures, and, more and more, directly with sponsors who own and run institutional-quality properties.
Pooled Investment Vehicles
Pooled investment vehicles are becoming more popular because individual investors can’t get into deals that are only open to institutional investors. Pooled investment vehicles (PIVs) are usually big funds that get money from many different investors, sometimes thousands of them. The fund sponsor then uses that money to invest in real estate that is good enough for institutions but doesn’t have to have institutional backing.
Putting money into PIVs has several advantages. For one thing, this means that small investors can now buy a broader range of products. Second, PIVs have more buying and negotiating power than an individual investor would have on their own. Lastly, small investors benefit from the fact that professionals manage PIVs.
Institutional Investors Invest in Commercial Real Estate For A Variety Of Reasons.
• Market Depth: Institutional-quality real estate tends to draw a steady stream of buyers and lenders with a lot of money. As a result, investors can usually get favorable conditions when they buy or refinance an asset. When they’re ready to sell, it’s easier for them to do so because buyers from all over the country and the world are eager to buy. This is true even if the economy is bad, when investors might not be as willing to put money into low-quality products. In practice, this means that institutional-quality real estate is more liquid than other types of commercial real estate.
• You can find better tenants: “Class A” products are usually “institutional quality” real estate. It’s usually in the best areas, and it’s normally built with high-quality materials and the latest building features. So, the institutional-quality real estate attracts top-tier tenants willing to sign long-term leases at higher rates. When there is a vacancy, it is easier to find strong tenants with good credit to move in.
• More predictable cash flow: Similar to the last point, investors can expect strong, stable cash flow from institutional-quality real estate because it attracts established, credit-worthy tenants who often sign long-term leases (usually between 10 and 30 years).
• Better rent growth and property appreciation: Investing in core areas means that investors can count on robust long-term growth in rents and property values due to the concentration of institutional-quality assets. During a real estate cycle, commercial properties in secondary and tertiary markets are more likely to go through bigger price changes.
Institutional quality real estate is usually either newer construction or older properties that have been updated and are well taken care of. For investors, this is critical since the less money they have to put into or pay for maintenance on a property, the newer it is. There is also less chance that it will stop working. Institutional-quality properties are more likely to have proper life safety systems, cross-docking capabilities, and optimal floor-to-ceiling ratios than Class B or Class C industrial properties.
There are clear benefits to investing in institutional-quality real estate, but an investor needs to decide if these benefits are more important than the costs. For example, institutional-quality real estate tends to have lower returns (between 5 and 6 percent, depending on the market and market cycle) because the prices of these lower-risk assets tend to go up due to intense competition among investors.
Remember that institutional-quality real estate and institutional investors are not the same things.
Institutional investors and sponsors have access to the same amount of information, but this is not the case in the crowdfunding sector. Institutional investors have more money and more power to spend than private capital investors, and they also have lawyers to help them negotiate terms and conditions.
How Private Capital And Institutional Capital Are Different:
“Private capital” and “institutional capital” are often used interchangeably. Institutional capital can be private capital, but not always the other way around.
Investors use the term “private capital” to describe any money a private company has (i.e., not a publicly traded entity). The people who own shares in this company have agreed to share both the risks and benefits of owning real estate. People who put their own money into a deal can get cash flows or other dividends as a way to make money. One good thing about investing in a private company is that it doesn’t have to tell the public about its finances. This is very different from REITs and other publicly traded companies, which have to send quarterly and annual reports to their shareholders. Once the reports are filed with the SEC, they are available to the public.
Institutional capital, on the other hand, comes from places like banks, pension funds, insurance companies, endowments, and so on. Private capital may, but need not, be utilized by institutional capital. Think about a retirement fund. Pension funds get money from people and sponsors, both public and private, and promise to pay a retirement benefit to people who will benefit from the fund in the future. The Employee Retirement Income Security Act (ERISA) is in charge of pension funds. This means these funds have to follow a few different rules and regulations than they would if the SEC were in charge of them instead.
Another significant difference between private and institutional capital is the willingness to accept risks. Institutional investors tend to look for “safer” plays, while private investors tend to be more willing to take risks. Because of this, institutional capital tends to put its money into companies traded on the stock market instead of the other option.
When investing in an institutional asset, the most important thing to look at is the sponsor’s honesty, motivation, and the benefits you get compared to other investments you may be making. Also, despite what others may tell you, even if the asset you are investing in has institutional quality, you are not investing “like an institution” most of the time.
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