What to Know about Investing in Institutional-Quality Real Estate

Commercial Real Estate Investing

Institutional investors, such as life insurance companies and pension funds, have historically been the only investors to have access to some of the most premier commercial real estate deals. And understandably so. These institutions will often invest large tranches of money – often $20 million or more, in a single deal or fund.

High-net-worth and other “retail” investors generally invest only a fraction of the capital, sometimes just $25,000 or $100,000 at a time. While this is not an insignificant amount of money, it simply pales in comparison to the investments institutions make.

As a result, individual investors rarely have access to the same types of deals. They are left to comb through smaller deals, ordeals that institutions have otherwise passed over. For too long, retail investors have just accepted this reality.

That’s beginning to change. Changes to SEC regulations have made it easier for sponsors to crowdfund capital from accredited investors, which they can then pool and collectively invest in larger deals. For the first time ever, retail investors are starting to gain access to institutional-quality deals alongside highly sophisticated sponsors.

What is Institutional-Quality Real Estate?

Most think of institutional real estate as being Class A properties located in top-tier markets. Newly-constructed office buildings in downtown Manhattan and San Francisco are a good example. These properties tend to be expensive, exclusive, and attract attention from investors all over the world.

Yet institutional-quality real estate includes more than just these trophy assets. In addition to office, institutional-quality real estate also encompasses retail, multifamily, and industrial/logistics. These are the for primary institutional “food groups,” if you will. In recent years, institutional investors have started to buy alternative property types as well, such as data centers, self-storage facilities, student housing and seniors housing.

 

Characteristics of Institutional-Quality Real Estate


There is no uniform definition of “institutional-quality” real estate. Each investor has a slightly different perception of what classifies as an institutional product and what does not. How someone defines institutional-quality real estate can depend on their motivation: someone may invest for security or yield, while others might invest for prestige.

That said, most expect an institutional asset to be in excellent condition, located in a top tier market, and be leased to stable, top tier (i.e., highly credit worthy) tenants.

Another way to define institutional-quality real estate is by classifying these properties as those of a certain size and scale. These properties often cost tens or hundreds of millions of dollars. However, in some cases, it is not a single property that costs this much, but a portfolio of properties that makes it institutional-quality. For example, a single-family home would not be considered an institutional-quality product—but a portfolio of 15,000 single family rental homes might be. A defining difference between traditional investment property and institutional-quality property is often scale.

Institutional-quality real estate will generally trade at relatively low cap rates, usually between 3 and 5 percent. Institutional investors, many of whom are risk-adverse, are often willing to accept lower returns when buying lower-risk, stabilized assets. They can pay more for these assets, as well, which further drives down cap rates.

 

Types of Institutional Investors


There are many types of institutional investors, including:

• Sovereign wealth funds: A sovereign wealth fund is generally a pension fund that invests on behalf of a state or county. They invest in a range of products from real estate to private equity to infrastructure and equities.
• Endowments and foundations: These are some of the most common institutional investors and include the investments on behalf of universities and large nonprofits. Endowments and foundations tend to be very sophisticated investors.
• Global pension funds: Global pension funds are similar to sovereign wealth funds and endowments, except they are investing large sums of money on behalf of private companies. Global pension funds, as their name implies, can be located all over the world, from U.S. to Europe, to Asia or the Middle East.
• Traditional commercial banks: These financial institutions offer traditional banking, lending and investment services to the general public. They also make investments of their own. Some of the most prominent commercial banks include Bank of America, Wells Fargo and JPMorgan Chase.
• Insurance companies: Insurance companies collect premiums from their customers and then re-invest those premiums into assets that generate returns higher than the U.S. Treasury (usually around 2%). The returns from those investments are then used to pay out claims to policyholders on a regular basis.
• Hedge funds: Hedge funds are a class of alternative investments that use pooled funds to generate above-market returns. Hedge funds are generally willing to take on more risk than other institutional investors in exchange for greater returns. BlackRock is one of the most well-known hedge funds in the U.S.
• Mutual funds: Mutual funds are pools of money collected from several investors for the purpose of investing collectively in stocks, bonds or other securities. These funds are professionally managed and increasingly, are willing to invest in commercial real estate as an alternative asset class.
• Private equity funds: This is another type of pooled investment vehicle, generally structured as a Limited Partnership and fixed for a term of five to ten years. These funds provide equity financing to private entities that are unable to raise capital from the public. Most investments are illiquid in nature, including commercial real estate.
• Large family offices: A family office is a privately held company that handles investments and wealth management on behalf of extremely wealthy families, usually with $100 million or more in assets combined. Family offices may have more or less experienced real estate investment teams compared to other institutional investors, and generally speaking, have slightly less capital to invest into individual deals.

The Benefits of Investing in Institutional–Quality Real Estate

Given that institutional-quality real estate has historically only been available to select investors, few retail investors understand the full breadth of benefits that these types of investments offer. These benefits include:

• Depth of market: Institutional-quality real estate tends to attract a large pool of both buyers and lenders. This means that investors can usually secure top-notch terms when buying or refinancing the asset, and upon sale, usually have interest from both national and international buyers. This is true even in the event of an economic downturn, where institutions may otherwise be hesitant to invest in lesser quality products. In effect, this makes institutional-quality real estate inherently more liquid than other commercial real estate product types.
• Access to better tenants: Institutional-quality real estate is usually considered “Class A” product. It tends to be located in premier markets and is constructed to be high-quality with robust amenities. As a result, institutional-quality real estate attracts top-tier tenants that are willing to sign long-term leases. In the event of a vacancy, there are usually many strong, credit-worthy tenants willing to fill the space.
• More predictable cash flow: Related to the point above, because institutional-quality real estate draws established, credit-worthy tenants that often sign long-term leases (typically ranging from 10 to 30 years), investors can expect to earn strong, stable cash flow.
• Better rent growth and appreciation: Because institutional-quality assets are concentrated in core markets, investors can expect strong rent growth and property appreciation over time. Commercial properties located in secondary and tertiary markets are more susceptible to wider swings over the course of multiple real estate cycles.
• Usually newer product types: Institutional-quality real estate tends to be either of newer construction or older properties that have been renovated and incredibly well maintained. This is important for investors because the newer the property, the lower the capital expenditures. There’s also less risk of functional obsolescence. For instance, an institutional-quality industrial asset is more likely to have proper life safety systems, cross-docking capabilities, optimized floor to ceiling ratios, etc. compared to a Class B or Class C industrial property.

How to Access Institutional-Quality Deals without Institutional Capital

Understandably, most individuals have far less money to invest in institutional-quality deals. This does not mean that these deals are entirely out of reach. There are other ways for individuals to access institutional-quality real estate.

 

Invest in Value-Add Deals that Result in Institutional-Quality Assets

Most institutional investors are somewhat risk-adverse, and therefore, are not willing to invest in Class B or C properties that need significant renovation. This creates an opportunity for investors willing to deploy value-add strategies that result in Class A assets. A sponsor might, for example, pool capital to invest in an outdated multifamily property that is otherwise well-located in a core market. The sponsor takes on the risk of repositioning the property but in turn, has the ability to own an institutional-caliber asset. The sponsor can then refinance and hold the property or alternatively, might consider selling to an institutional investor who would not have purchased the property prior to its stabilization.

Invest in a Syndication with Other High-Net-Worth Individuals

Another alternative is to invest in a syndication with other high-net-individuals. By aggregating sufficient capital, the syndicator can use that pooled capital to invest in institutional-quality real estate as though it were an institution. For example, a syndication might require a minimum $500,000 investment. With 40 individuals making that minimum investment, the syndicator now has at least $20 million to invest in an institutional-quality asset.

 

Co-Invest Alongside Institutional Investors

Sometimes, institutional investors will invest in a fund that is also open to accredited investors. The institutional investors might be given a preferred equity stake versus retail investors who might be given common equity. This co-investment model provides retail investors with the full spectrum of benefits that come with institutional investing, without having to put up institutional capital themselves.

 

How to Start Investing in Institutional-Quality Real Estate

Ultimately, anyone who invests in institutional-quality real estate will most likely do so through a syndication or fund. Therefore, it is critically important for investors to do their due diligence on the sponsor behind that syndication or fund.

When evaluating sponsors, be sure to look at the sponsor’s experience and track record. Some sponsors, like High Peaks Capital, have strong pre-existing relationships with institutional investors and therefore, understand how to “think like an institution”. This institutional mindset is important, especially for any sponsor promising to deploy a value-add strategy that results in a Class A asset. Someone who has experience with institutional investments already will better understand how to reposition the asset to become institutional caliber.

Sponsors who have worked with institutions will also be highly adept at analyzing and underwriting deals, which is important if you are going to entrust that sponsor with your hard-earned capital. Institutional investors have robust systems and processes in place for underwriting deals; a highly-qualified sponsor should be able to deliver this same sophistication to retail investors, as well.

Are you an accredited investor looking to access institutional-caliber real estate deals? Contact us today. As a debt and equity broker for some of the largest commercial real estate owners in the country, we always have our pulse on the market and opportunities coming down the pipeline. Our experience withinstitutional investors gives us unique perspective that we bring to every deal on behalf of individual investors looking to achieve similar results. Learn more today.