Commercial Real Estate
Investing 101
RealCrowd
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2013 RealCrowd. All rights reserved.
A better way to invest in real estate.
What is RealCrowd?
RealCrowd offers direct real estate investing opportunities to accredited investors. All properties that are offered are prevetted, institutional quality assets managed by the top real estate operators across the United States. A commercial real
estate (CRE) investment is any property that produces rental income and is purchased with the anticipation of producing
a profit. Apartment complexes, office buildings, industrial distribution facilities and retail properties are all commercial real
estate investments.
Investing in commercial real estate has historically produced outstanding returns yet is a nearly impossible barrier to entry
market, requiring very large amounts of capital; extensive knowledge of how to identify, underwrite and research
opportunities; proper networks to access investment opportunities; and the wherewithal to commit a large amount of
capital into a single investment. Until now.
Why Read this eBook?
This e-book is the culmination of nearly 20 years of experience and over $3 billion of activity in office, industrial,
retail, multi-family and development transactions.
This ebook will help you formulate the answers to the following questions:
Why invest in commercial real estate?
What are the types of assets to consider purchasing and why?
How do I formulate my own commercial real estate investment strategy?
Commercial Real Estate 101 is the first of many short and easy to follow eBooks published by RealCrowd with the intent
of demystifying commercial real estate. The primary goal of the book is to give investors the knowledge to invest in, what
we believe, is the greatest wealth creation asset class in the world - commercial real estate investments.
RealCrowd
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Why commercial real estate?
Real Estate: Quite Possibly The Best Asset Class
Commercial real estate is one of the most dynamic investment classes in the world. Commercial real estate is the only
major asset class that produces high yields, significant equity buildup, can be efficiently leveraged for massive gains, has
the security of a hard asset that you can see and touch (intrinsic value regardless of an income stream), and provides
some of the best tax advantages.
The major fortunes in America have been made in land.
-John D. Rockefeller
Commercial Real Estate Investing 101
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Commercial Real Estate Produces Significantly More Income
One of the biggest advantages of Commercial Real Estate is the high annual cash return that it produces.
In fact,
commercial real estate income stream can produce three times the average stock dividend yield and four times
the average bond yield. The chart below demonstrates the income each asset class produces based on a $1 million
investment.
Annual Income Produced on a $1 million investment
Real Estate Cap Rates
Stock Dividends
Suburban Office
$78,000
Retail
$72,000
DT Office
$59,000
Multi-Family
Dow 30
S&P 500
Bond Yields
$58,000
$29,000
$21,000
AAA Bond
$19,100
US Treasury
$18,500
Average Cap Rate Source: Real Capital Analytics 2012 / Average Stock Dividend Q1 2013 / Average 10 Year Bond Yield Q1 2013
Investors use cap rates to measure returns. More detail on cap rates
is provided in RealCrowds Commercial Real Estate 201 eBook.
Commercial Real Estate Investing 101
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Asset Allocation - A Key Role in Determining Results
It is recommended by leading experts that investors have 20% of their investment portfolio in income producing real
estate. David Swenson, Chief Investment Officer of the Yale Endowment, a trustee of TIAA-CREF (a Fortune 100 financial
services organization), and the author of Unconventional Success: A Fundamental Approach to Personal Investment
created what is known as the Yale Model which has produced staggering returns of nearly 14% annually. The portfolio
has 22% of its assets in income producing real estate investments and Yale is increasing that allocation further.
Asset allocation decisions play a central role in determining investor results...approximately
90 percent of the variability of returns stems from asset allocation, leaving approximately 10
percent of the variability to be determined by security selection and market timing Careful
investors play close attention to determination of asset class targets.
David Swenson - CIO of the Yale Endowment
Commercial Real Estate Investing 101
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Commercial Real Estate: A Simplified Look...
Commercial Real Estate is a very simple investment vehicle. The basic premise of making money in real estate is
simplified below:
Te n a n t s p a y re n t , u s u a l l y
Tenants Pay Rent
monthly. Revenue can also come
from parking, signage, etc.
Maintenance
Admin
Building Expenses
Mgmt
are Paid
Utilities
The real estate operator/property
manager pays building expenses
from the rental income.
Janitorial
Insurance
=
After expenses are paid, the
Investors are Paid
remaining income is distributed to
investors.
Upon sale of the property, equity is distributed back to investors.
Commercial Real Estate Investing 101
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Real Estates Amazing Long Term Income Benefit
Unlike other asset classes, commercial real estate is typically leveraged with financing. Sure you can purchase stocks on
a margin account or commodities at a fraction of their price, but only commercial real estate provides rental
income that covers debt payments. This makes commercial real estate an outstanding long-term investment class
because as your tenants pay down the financing for you, equity is built up in the asset. Once you no longer have debt
payments, your cash return instantly increases multiplying your cash flow multiple times over.
Holding an Asset Through Loan Payoff Can Produce Massive Returns
Annual Cash Return in Year 1
7.5%
Annual Cash Return AFTER Loan is Paid O
28.9%
Increase in Annual Cash Return from Year 1
285%
Increase in Total Equity AFTER loan is Paid O
273%
Debt
Equity
Annual Cash Return
$8,000,000
$7,000,000
28.9%
$5,000,000
$4,000,000
7.5%
9.5%
11.8%
14.3%
Equity
$6,000,000
Year 16
Year 21
$2,000,000
$1,000,000
$0
Debt
$3,000,000
Year 1
Year 6
Year 11
Although this is a very simplified analysis, this shows the dramatic effect leverage can have on returns. Assumes
a 20 year fully amortizing loan, a conservative 2% annual Net Operating Income increase, and 65% LTV.
Commercial Real Estate Investing 101
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Magnify Your Equity Return Using Leverage
Real Estate also allows for magnified equity buildup on a
However, if you were to purchase a $10 million asset
shorter-term basis by using financing, which is illustrated
utilizing only $1 million of your own money and financing
below.
If you were to purchase a $10 million asset all
the remaining (allowing the rental income to make the
cash and sell the asset in the future at $11 million, you
debt payments), then sell the asset, you have also made
have made $1 million profit, a 10% return.
$1 million profit, however achieved a 100% return.
$10M Cash Down and No Financing
$1M Cash Down and $9M Financing
$11M sale - $10M purchase = $1M profit
$11M sale - $10M purchase = $1M profit
$1M profit $10M cash down = 10% return
$1M profit $1M cash down = 100% return
Although this is a very simplified comparison, the analysis shows the dramatic effect leverage can have on returns.
Commercial Real Estate Investing 101
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REITs Versus Direct Real Estate Ownership
Investing in a Real Estate Investment Trust (REIT) is a popular way to diversify into real estate. However when you
invest in a REIT you do not actually own real estate, you own a share of stock in a company. The following are
notable attributes of REIT investing:
High Fees - A private REIT can charge up to 17% up front before your investment even touches the real
estate. A recent REIT prospectus disclosed the following fees - sales commissions=6.5%, dealer manager
fee=3.5%, organization and offering expenses=2.42%, acquisition fees=1.75% and acquisition
expenses=0.96%!!! For every $100 you invested, less than $85 actually went towards the real
estate! Additionally, a REIT is only required to distribute 90% of the income generated by its properties
back to investors, significantly lowering overall returns.
Lower Average Returns - The average publicly traded REIT dividend is 3.4%, significantly lower than
average returns from direct commercial real estate ownership. Many individual properties can distribute an
cash return ranging from 6% to 12% annually.
High Volatility - Given that REIT shares are stocks traded in the stock exchange, they are subject to the
high volatility and market shifts of the stock market as a whole.
Lack of Control - The REIT structure is designed to provide an investment similar to what mutual funds
provide for stock investing. Although there is a diversity of assets, there is also a lack of control over which
assets are being purchased. Just as many investors have control of investing in individual stocks on
platforms like E*TRADE and Scottrade, they now have similar control over their commercial real estate
portfolio through RealCrowd.
Less Transparency - Although REITs have strict reporting guidelines, most investors know very little about
the properties in a REIT portfolio. Direct real estate ownership increases the overall transparency of the
If your primary objective is to participate in the numerous benefits that real estate has to offer discussed
Debt
above, then a REIT does not achieve many of those goals.
Commercial Real Estate Investing 101
Equity
investments.
[Link]
What asset class should I buy?
There Are Multiple CRE Categories - Which Type Should I Buy?
Now that you know the benefits of commercial real estate investing, which assets should you consider? That answer is
that it really depends on what your personal beliefs are about the real estate market. The founders of RealCrowd had the
benefit of literally thousands of interactions with investors across the United States that purchased office, industrial, retail
and multi-family properties and we have summarized investors mindset for each asset class below.
Asset Category
Multi-Family
(Apartment
Complex)
Primary Mindset (Why buy this asset class?)
So long as there are people, there will be a need for housing. As the population grows,
demand for housing will increase as well. Adjustments to inflation can be made annually
through rental rate increases (except in rent controlled areas). The current generation
prefers mobility and are not as apt to purchase a home and settle down, therefore will
continue to rent.
The United States economy will continually be moving away from manufacturing and
Oce Buildings
agriculture to a service focused economy. The tech world thrives in offices and
collaboration is key. More companies are opting to bring their workforce back into the
offices versus letting them work from home (e.g. Yahoo).
Industrial
Buildings
Retail
Properties
As eCommerce continues to grow, so will demand for industrial distribution buildings.
[Link], Zappos, and other online retailers are joined by smaller businesses that will
drive demand for industrial buildings.
People will always have a need and desire to go to a bricks and mortar retail
establishment despite the advent of eCommerce. There is a social and even therapeutic
aspect to shopping that will never be replaced by online shopping. Generally as the
economy improves the retail sector can see the increase in demand immediately.
Obviously there are more reasons to purchase each asset class, but this should give you a good start to forming your
own philosophy in investing in real estate. Many investors diversify their investments across all asset classes.
Commercial Real Estate Investing 101
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What types of opportunities are
there?
Commercial Real Estate Investment Deal Types
Just like how there are different types of stocks such as growth stocks where shares are expected to grow at an above
average rate, there are different types of opportunities in the commercial real estate investment world. Below is a
summary of the types of CRE opportunities:
Deal Type
Core
Property Attributes
Investor Opportunity
Generally core assets are 85%-100% leased with a rental
These assets provide the highest level of
stream secured by long-term leases (over five years) -
income security - Generally they provide
These assets are generally located in primary locations
moderate appreciation and a lower yield.
with strong market fundamentals - The assets are typically
newer and require very little capital improvements.
Core-Plus
Generally, core-plus assets are leased between 70% and
Core-plus assets provide an in-place income
85% - These assets offer the ability to lease up the
stream with the opportunity to increase the
remaining space to improve the income of the asset -
income in future years. These assets may have
They may also have below market rental rates and leases
a lower in-place yield, but offer higher
that expire shortly (within 1-3 years) - These assets can be stabilized yields as the asset gets leased up.
located in primary and secondary markets and may
Generally, an in-place yield could be 5% to 7%
require some capital improvements.
with the opportunity to increase it to 8% to
10%.
Value Add
Value Add assets are the growth stocks of the
Value Add assets provide the most upside
commercial real estate world. Generally, they are below
when compared to core and core-plus assets.
70% leased and may require physical improvements to be These assets produce lower initial returns
able to compete for new tenants. These assets are
between 0% and 4% initially, but can grow to
located in primary, secondary and tertiary markets.
8% to 12% after the work has been completed.
Land with the opportunity to develop commercial office,
Development opportunities can be risky
industrial, retail or multifamily.
depending on how they are structured. Having
Development
a tenant with a lease in place prior to
construction (Build to Suit) provides significantly
less risk than an asset without leases in place
(speculative development).
Commercial Real Estate Investing 101
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What is my investment strategy?
Identifying your Investment Goal
Commercial Real Estate is an excellent long-term investment that matches very well with a variety of investment
objectives. The following is a summary investment objectives by generation.
Generation
Baby
Boomers
Investment Goals
Investments
At retirement, obtaining the highest cash income
Commercial real estate provides
without reducing your principal equity investment is
significantly higher annual cash returns than
paramount to ensuring an extended retirement
stocks, bonds, treasuries and savings
income stream.
rates. Baby Boomers could consider wellleased multi or single tenant assets that
Born
provide higher cash on cash returns. Core
1946-1964
and core-plus assets could be considered
by Baby Boomers to maximize their income
potential.
Generation X has time to build up equity in
The longer-term time horizon to build up a
commercial real estate. Generally, this generation has retirement portfolio and lower liquidity of
Generation X saved for their retirement through a company 401K
or Echo
Boomers
Born
1965-1979
commercial real estate plays well into
plan which is often limited to pre-chosen mutual
considering using real estate as a
funds with lackluster performance. Generation X
retirement vehicle for this generation of
could consider other retirement plan options,
investors. Core, core-plus, value add and
including a self directed IRA, checkbook IRA, or Solo development assets could be considered
401K plan which would allow them to have
by this generation with the intent of owning
significantlygreater flexibility to invest in asset classes the real estate long term and paying off the
other than mutual funds.
debt to produce maximum cash flow at
retirement.
Generation Y Generation Y has very similar investment objectives
or Millennials
Born
Generation Y has the ability to consider the
as Generation X, which is building up maximum
entire menu of real estate, core, core-plus,
equity in the early years, which will produce the
value add and development.
highest income at retirement.
1980-2000
There have been few things in my life which have had a more genial
effect on my mind than the possession of a piece of land.
-Harriet Martineau
Commercial Real Estate Investing 101
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Commercial Real Estate 201
Thank You
Thank you for your interest in commercial real estate investment at RealCrowd.
We value our investors and are
committed to offering the highest quality investments with the best real estate operators across the United States.
If You Are Interested in Learning More
Please email us at CRE201@[Link] to obtain the CRE 201 ebook. The ebook will provide answers to the
following questions:
What factors affect real estate values?
How do I value commercial real estate?
How do I run a simple cash flow analysis? (Computing the Net Operating Income)
What is a capitalization rate and how is that determined?
How do I determine if the asset is located in a quality location?
What should I be looking for in a quality real estate operator?
Again, please email us to obtain your copy of CRE 201 ebook.
Commercial Real Estate Investing 101
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CRE Terms & Definitions
Absorption
Absorption is the way commercial real estate investors gauge tenant demand and is measured in square footage. Total
absorption is the total new square footage leased by tenants. For example, if a building had 20,000 square feet of new
leases in 2013, its total absorption is simply 20,000. The more relevant metric to view is net absorption which is the total
new square footage leased minus the total square footage of tenants that no longer occupy their suites in a given time
period. If a building had 20,000 square feet of new leases in 2013 and 5,000 square feet of tenants leaving, its positive
net absorption is simply 15,000 square feet. Absorption can be measured by building or by entire markets.
Capitalization Rate (Cap Rate)
The cap rate is the percentage of funds you paid for the building that comes back to you annually (not taking financing
into consideration). As an example, if you purchased a building for $1,000,000 that returned $60,000 annually, your cap
rate is simply 6%. The calculation is $ NOI $ Price = Cap Rate %
Cash-on-Cash Return
The cash-on-cash return is the percentage of funds you invested in the building that comes back to you annually after
making financing payments. Your cash-on-cash return is often higher than your cap rate if favorable financing is put in
place.
Contract Rent
Contract rent is the current rent being paid by the tenant according to their lease. Contract rents are measured by
square footage in commercial real estate. For example, if an office tenant is paying $21,000 a year for 1,000 square feet
of space, their contract rent is $21.00 per square foot per year. Contract rents may also be quoted monthly.
Market Rent
Market rent is the rental rate that a specific location could achieve if it were available to lease today. Like the contract
rent, market rent is quoted per square foot. Investors compare market rent to contract rent to see if there is an
opportunity to increase rental rates once a suite becomes available.
Net Operating Income (NOI)
The net operating income is the total rental income from all of the tenants, parking revenue, and other revenues minus
operating expenses (taxes, insurance, management, maintenance, utilities). The net operating income is one of the first
metrics and investor will review/verify because the cash return to investors is paid from the net operating income. Net
operating income does not take into consideration financing nor does it include capital improvement costs.
Commercial Real Estate Investing 101
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Occupancy
Occupancy is the percentage of occupied suites in a commercial real estate property or market. For example, if a
100,000 square foot building is leased and occupied by 95,000 square feet of tenants, the buildings occupancy is simply
95%. Occupancy can be measured in buildings and in entire markets.
Vacancy
Vacancy is the percentage of unoccupied suites in a commercial real estate property or market. For example, if a
100,000 square foot building is leased and occupied by 95,000 square feet of tenants, the buildings vacancy is 5%.
Like occupancy, vacancy can be measured in buildings and in entire markets.
Commercial Real Estate Investing 101
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