Buchanan: With cash to invest, which real estate is best bet?

As 2022 commences and with four seasons ahead, mid-term elections and a few resolutions still intact, I thought it would be revealing to discuss the ways folks invest in commercial real estate.

Recently, I had a conversation with a friend and client of mine. He’s certainly not a novice as he’s owned commercial real estate. The subtle difference, however, is he’s owned it to house one of his operating companies. Some would refer to this as an owner-occupant.

On this day, his wife and I reviewed the various genres and my recommendations for their portfolio. I should also mention, they wanted to deploy money into an income property after the sale of another income property. Therefore, we would be utilizing a tax-deferred exchange – also known as a 1031.

Currently, their holding is a special purpose building in town, one the family has owned for decades. Typical in this scenario: the neighbor approached them about their willingness to sell. Usually met with a no, this go-around instead was met with a yes. A contract was drawn and closing is scheduled mid-month.

During our lunch meeting – after all the grandkid stories were exhausted – his question was simple. If this were your money, how would you invest it? Here’s what I shared with them.

You’ll first need to determine your comfort level with risk. Next, determine how actively you’ll manage your acquisition. Finally, what is your exit?

Let’s start with risk. Generally, the riskier a stake in real estate the higher the return. In our parlance, this is capitalization or cap-rate.

Consequently, a 20-year industrial lease with Amazon as the occupant should yield less than a Petco store with a 2023 expiring lease. Why? Because the rent Petco pays may be interrupted next year. They may bolt! You’ll then have to originate a new lease with all the appurtenant costs of down-time, brokerage commissions, rent concessions and the like.

Some investors may find favor. If the Petco can be bought at a discount, costs of a new lease covered, the rewards can be great. Other, more risk-averse buyers would prefer the lower “guaranteed” return a long-term lease affords.

How you’ll collect the rent – or the level of your involvement – is your next consideration.

Generally, a retail strip or incubator industrial property will sport multiple tenants with varying lease expirations, credit worthiness, and drama. “Sorry, can’t pay you this month because one of our customers stiffed us.”

For a percentage of the rent check, a property manager can be employed. You then avoid the calls on Saturday with a leaking toilet. But … the luxury of a middleman depletes your check at the end of the month.

Single-tenant assets, like our Amazon example, have virtually no management. In fact, if the lease is triple net in nature, you simply collect each month with no management necessary.

Finally, let’s consider your exit.

You see, pouring money into commercial real estate is not like buying a stock, bonds, precious metals or art. Sure, risks abound with any gamble. The difference is the liquidity.

If you buy a share of General Motors and decide to sell it, buyers are plentiful and stock markets prevail. Commercial real estate is a bit trickier.

Imagine selling in 2009. Yikes! Therefore, how you’ll depart the investment must be weighed.

Some like to buy, put the token on the shelf and allow their grandkids to decide what to do years from now. Others prefer to create value and bail.

Certain types of buildings lend themselves to value addition. Take office buildings as an example. With our pandemic-fueled uncertainty with office suites, some may be drawn to the higher returns an investment in office may allow. Fill it with good-paying, long-term tenants and sell it. Love it or list it, indeed.

Our guy prefers a lower risk, little management and plans to hold long-term. Therefore, at the end of our discussion, we decided to focus our search on a single-tenant industrial building with a mid-length lease of three to five years. Our expectation is a return in the 4% range.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.

Source: Orange County Register