Passive Investing: An easier way to build your Commercial Real Estate Portfolio

May 3, 2018

While many people are interested in the potential returns and relative stability that commercial real estate can offer, the idea of owning and managing real estate may seem daunting even to seasoned investors. Inquiring investors may wonder: “How could I afford to purchase an apartment complex or office building? How do I know if the price is right? Where will I find the time to manage a property?”

That’s where passive real estate investing comes in. In order to understand what passive real estate investing is, one must understand what active real estate investing encompasses. Typically, a reputable and experienced real estate firm, often referred to as a sponsor, will spend months sourcing a transaction by tapping into their network of real estate professionals to find a well-priced deal with upside potential. Upon finding such a transaction, the sponsor will spend weeks underwriting the deal, which means dissecting the property’s financials and ensuring that their proposed business plan will work. In addition, the sponsor performs extensive due diligence, which includes a review of title and environmental conditions at the property.

Sponsors may look at dozens of properties until they settle upon a transaction they wish to acquire. At that point, the sponsor must negotiate with the seller and ultimately close on the property. The hard work doesn’t stop there. Upon taking over ownership of the property, the sponsor must start to implement their business plan. This can include replacing the onsite management company, conducting extensive interior and exterior renovations, improving the tenant base and property’s perception in the marketplace, all intended to increase the property’s cash flow. After a period of ownership sufficient to complete the business plan, the sponsor will typically market the property for sale in order to realize a gain.

Obviously, active real estate investing is a tough work and best left for the experts. However, through passive real estate investing, an investor can invest with experienced sponsors who will acquire, manage and operate a property, thereby achieving the returns and stability that make real estate desirable, but without the need for time or experience. There are several ways that a person can participate in commercial ownership through passive real estate investing, as outlined here in a previous article. Once an investor understands his or her investment goals and makes an investment, passive investing requires minimal demand on the investor’s time.

The newest way to passively invest in real estate is through commercial real estate crowdfunding, an industry that has seen increasingly popularity and maturation over the last few years. According to some industry resources, there are approximately $2.5 billion worth of crowdfunded real estate investments in the United States – roughly 0.04% of the total real estate industry. By 2025, that number is expected to grow 100 times to over $300 billion.

Commercial real estate crowdfunding entails a sponsor syndicating an investment opportunity through the internet. In other words, the sponsor gives investors the ability to invests alongside that sponsor and other like-minded investors. The sponsor then uses those pooled funds to acquire the asset and execute on the business plan, all while maintaining a dialogue with investors and distributing profits when available. Through this arrangement, an investor can own a commercial property without the headache of dealing with tenants, contractors, and even local government officials. In fact, this method of investing allows an investor to build a diversified portfolio of properties that can help minimize the risk of investing directly in a single asset.

A real challenge for investors considering commercial real estate crowdfunding is choosing the right deal to invest in. It is critical that investors understand what to look for when evaluating the merits of a deal, such as the internal rate of return (IRR), equity multiple, hold period, and the local competitive market. One of the most important factors that investors must diligence is the sponsor running the deal. Being that a passive investor will not have any day-to-day management rights over an investment, the sponsor selection cannot be underestimated or overlooked. The investor should scrutinize the sponsor’s experience, transaction history and current real estate owned. It is also important to verify that the sponsor has picked the right local partners such as the property manager and general contractor. This is especially true if the sponsor’s business strategy calls for ground-up construction or extensive renovations.

In summary, anyone can build their own real estate empire without having to get their hands too dirty. There are many passive real estate investment options available with experienced sponsors that offer attractive potential returns. Investors should educate themselves in understanding how to choose the right partner to invest alongside and how to evaluate the transactions that best meet their investment objectives. With that knowledge, investing in sophisticated real estate transactions can easily be done from anywhere – even the comforts of one’s home or office.