How to Get Into Commercial Real Estate Investing
Take your life savings, invest it all in a single momentum stock, then sit back and see how easy it is to go about your normal life. See if you can go one single day without checking the price of your treasured stock. That emotional roller coaster epitomizes what it’s like to be a retail investor who has chosen to maximize risk by not diversifying their investments. It’s probably more common than you think based on all the “what’s one stock you would own” emails we get from first-time investors.
It’s not just about diversifying your money across multiple stocks, it’s also about diversifying across asset classes. When the stock market gets absolutely pummeled, it becomes increasingly apparent how other asset classes can provide diversification. Cash, art, real estate, gold, and even bitcoin are alternative methods of investing your wealth which are weakly correlated – in some cases, negatively correlated – to the broader stock market. Today, we want to talk about an asset class that’s largely been out of reach for your average Joe investor – commercial real estate investing.
Investing in Real Estate with REITs
While venture capital firms are eager to fund early adopters who think that blockchain technology will provide retail investors a way to attain fractional ownership of properties, real estate investment trusts (REITs) have been doing that for years. They’re like little exchange-traded funds for real estate investors. In fact, not too long ago in 2016, the Global Industry Classification Standard (GICS) added an eleventh sector called “Real Estate” to house all the available REITs out there. One popular REIT is Realty Income (O), the “monthly dividend company.” It’s a portfolio of 6,400 commercial real estate properties diversified across the United States in various industries.
Investors like REITs because their correlation with the broader stock market decreases the longer you hold them. However, in this most recent downturn, REITs haven’t exactly provided a safe haven because investors are concerned that commercial tenants may have some problems staying in business. Consequently, there is no short-term diversification effect for owning commercial REITs at the moment. For sophisticated investors, there are other alternatives from fintech startups like EquityMultiple that offer acceptable levels of risk along with above-average yields.
EquityMultiple – A Commercial Real Estate Investing Platform
Founded in 2015, New Yawk startup EquityMultiple has taken in $3.9 million in funding so far to develop a platform that allows for accredited investors to invest in real estate projects alongside experienced real estate investors. That’s a key distinction to make here. This isn’t real estate crowdfunding, it’s the ability for investors to participate in actual projects that professional real estate developers have crafted which take advantage of economies of scale and certain tax breaks. So far, EquityMultiple has taken in around $150 million of funds to participate in about $2.5 billion worth of real estate projects. These projects represent various property types, from apartment buildings to office buildings to multi-family properties.
Update 06/23/2021: EquityMultiple has raised $4.8 million in its latest funding round. This brings the company’s total funding to $9.8 million to date.
Compared to residential real estate, commercial real estate is a totally different animal. Rarely does Joe consumer get to see how the sausage gets made in the complex world of commercial real estate financing. Everything is different, from interest rates to duration. Each offering is structured with its own terms, and only around 10% of the projects submitted to EquityMultiple are selected to assure a high level of quality. One of the firms backing them is Mission Capital, a leading national real estate capital markets firm, and one that certainly helps them find good deal flow.
In order to understand how the EquityMultiple platform works, we took a look through their past and present opportunities which allow accredited investors to invest in commercial real estate with as little as $10,000. One of the more interesting active offerings available involves renting a warehouse to Amazon for about five years so they can use it to ship American consumers more stuff.
The minimum investment amount is quite high for this offering – $100,000 – because, well, you’re dealing with the biggest company in the world. Here’s what this interesting commercial property investment looks like.
The Triple-Net Lease
The participants in the project are EquityMultiple alongside Mirae Asset and RCX Capital Group. A Trust was formed to acquire a one-million-square-foot warehouse for a total purchase price of $76.6 million in December 2018. In case you need some perspective, here’s what one million square feet looks like (it’s the actual warehouse):
After the Trust purchased the property, they leased it to Amazon.com for a “15-year initial term with 1.75% annual rent escalations structured as a triple-net lease, where the Tenant is responsible for real estate taxes, insurance, and property operating costs.” Prior to EquityMultiple’s servicing fee ($30,000 a year for the entire $6 million of participation in the offering), the project is expected to produce “a 5.5% Year 1 cash yield and 5.7% to 6.3% in years 2 through 5, respectively, inclusive of annual lease escalations of 1.75%.” In other words, Amazon’s rent will increase by 1.75% every year giving you a raise on your income (not really going to beat inflation but better than nothing). You also get to enjoy a tax break that only institutional investors have enjoyed up to this point – the 1031 exchange tax break.
Commercial Real Estate Tax Breaks
EquityMultiple published a great blog post which explains that a “1031 exchange” real estate investment allows you to defer capital gains tax on the sale of property if you use the proceeds from the sale to buy another property. And the benefit? “Deferring taxes owed today can allow for greater investment activity in the near term, which can have a compounding effect over time and accelerate the growth of a given investor’s portfolio.” In other words, you don’t have to pay tax on your profits if you just keep postponing it and growing your property portfolio.
Now, we’re not going to get into what this means for your own personal tax situation, but taking advantage of tax breaks is another perk that comes with investing in many commercial real estate projects. For example, the below active offering on EquityMultiple involves a 497,500-square foot industrial facility located in Goodyear, Arizona in an “opportunity zone.”
In our recent article on urban planning, we talked about opportunity zones (OZs) which are designated areas that the government has created to incentivize companies to invest in low-income areas. This project takes place in an OZ so that investors can enjoy benefits that include “tax deferral on invested capital gains, reduction of those deferred taxes by up to 10%, and the elimination of new capital gains tax on appreciation of the investment if held for at least ten years.” Those are some pretty big perks that will have a meaningful impact on your returns over time.
Commercial Real Estate Investing vs. REITs
When comparing these types of projects to REITs, it’s really apples and oranges. In one case you’re trading an equity-like asset with exposure to thousands of properties, and in the other case, you’re investing in very specific projects. The cash flows are also very different as well. Each has its own merits. With a REIT, you can set it and forget it. With EquityMultiple, you need to be very hands-on – at least initially – to understand the mechanics of each real estate investment on offer. There are three broad categories of projects – syndicated debt, preferred equity, and equity – each with their own risk profiles. At a minimum, you ought to understand the difference between the three.
EquityMultiple isn’t the only firm offering a commercial real estate investment platform. Last year, we wrote an article on Low-Risk Passive Income That’s High Yield which looked at a fintech startup called Yieldstreet which developed a platform that allows retail investors to access “asset-based investments” that provide target returns of 8 to 20% with one to three-year durations. Last we checked, they were expanding into other asset classes like art. We like EquityMultiple for commercial real estate investing because that’s their forte. (The team of real estate professionals at EquityMultiple has closed over $80 billion in real estate transactions.) If you’re interested in learning more about the types of investments that come up, just take a look at the past deals they’ve closed.
When it comes to choosing which fintech to use for commercial real estate investing, choose one that stays focused on just that – commercial real estate investing. As for dabbling in other asset classes like supply chain finance or art, choose fintechs that specialize in these areas (we found a great fintech for art investing we’ll be highlighting in a coming piece).
Retirees have lots of time on their hands, and many curious ones are tempted to take a hands-on approach with their retirement savings. Real estate investment opportunities on EquityMultiple are admittedly pretty interesting. You’re able to take advantage of certain obscure tax breaks while learning about how the commercial real estate industry works and receiving some low-risk passive income. The model seems to suit high net worth investors who seek new sources of diversification during uncertain times and have the desire to learn about the mechanics of each commercial real estate offering as it pops up.
We sold our Global X Fintech ETF holding and used the proceeds to purchase a legaltech stock with a 70% market share. A $50 billion opportunity awaits, and they've only achieved about 3% penetration – plenty of room to run. Become a Nanalyze Premium annual subscriber and we'll show you our entire portfolio of more than 30 tech stocks.