Investing in commercial real estate is second nature for some, but often foreign and daunting for others. This can especially be the case when considering an acquisition of a shopping centre, office building, or taking on a development project. There are many barriers to entry in acquiring commercial property which preclude passive investors from doing so. Some notable barriers include:
- Exceptionally high land/property values – especially throughout British Columbia,
- Ongoing – and material – increases in construction costs that are not only impacting Metro Vancouver but several markets throughout Western Canada,
- Underwhelming yield-returns (ie. cap rates) that can be off-putting for seasoned and rookie investors alike,
- Inability to qualify for suitable financing; and,
- General lack of experience in owning and managing a commercial asset or development project.
Considering the above challenges persisting in today’s marketplace, investing in a syndication, where multiple investors contribute equity to a “deal” through a limited partnership, is an excellent way to mitigate one’s risk and to dip the proverbial toe in the water. In this circumstance, typically the General Partner (“GP”) would present an investment prospectus to its prospective Limited Partners (“LP”) outlining the details of an investment opportunity brought forth and managed by the General Partner. Typically, the GP will contribute a minority equity position (but not always) and will be rewarded through the success of a project or investment on the backend or disposition of the asset; this is often referred to as the “carry.” Delineation of how equity positions and percentages are presented or negotiated is not the focus of this post but more so the 5 W’s (who, what, when, where and why) that an investor should investigate when considering investing in a syndication as a Limited Partner.
WHO
Perhaps the most crucial question to ask yourself when being presented with an opportunity to invest in a syndication is who the entity or person behind the scenes in the role as the General Partner or leading investor/developer is. There are many players with incredible track records and rapport but there are also just as many that lack expertise and, in some limited cases, business ethics. It is critical to do as much research on the lead entity (the GP), as on the actual investment opportunity, to ensure there is justifiable confidence in the ability of the General Partner to execute the strategy presented in the original investment prospectus.
WHAT
Some investors rely solely on a GP’s track record and ignore the investment details altogether. That approach may be reasonable for experienced investors, but a first-time LP investor should thoroughly understand what exactly they are investing in. Is it a passive income investment that will produce steady returns with nominal upside? Or a value-add investment deal that yields lower shorter-term returns but has a highly profitable exit strategy? Or is it a development site that is subject to market forces outside the control of the GP,and as a result, has a higher risk / higher reward? Each scenario will have its own risk vs. reward profile that should be assessed prior to investing.
WHEN
There is an old saying in our industry, “don’t wait to buy real estate, buy real estate and wait.” This strategy has proven to be highly lucrative for those who had the foresight to purchase real estate decades ago and demonstrated the patience to hold on during many market cycles. That said, “now” might not always be the best time to invest. In the context of today’s marketplace, there is smart money sitting on the sidelines waiting for further market corrections. On the other hand, there is smart money investing throughout the region in a variety of different asset classes. At the end of the day, no one has a crystal ball, but understanding the macro and microeconomics that impact real estate might persuade or dissuade one from investing at any given moment.
WHERE
Knowing your geography is part and parcel with understanding where to invest in commercial property. Historically speaking, Metro Vancouver real estate has been perceived as a haven for capital due largely in part to proven capital appreciation but more importantly, its liquidity. Owning a liquid asset can help put the mind at ease if an unexpected need for capital is required.* If one is considering an investment opportunity in a secondary or tertiary market the liquidity of it can potentially become more compromising. If considering an asset in a secondary or tertiary market, make sure that the ongoing cash yield (dividend) is risk adjusted. For example, and hypothetically, a commercial asset in Metro Vancouver might produce a 4.5% ongoing return, whereas the same asset profile in Northern B.C. should be risk adjusted to 6.5% ongoing return because there is less opportunity for land appreciation and likely less liquid.
*Keep in mind that often in GP/LP structures, the GP has the controlling interest and can unilaterally decide if and when an asset is disposed.
WHY
Investing in real estate should always be considered when seeking a diversified portfolio. We invest in real estate for two primary reasons:
- Capital Appreciation
- Cash Flow
Owning real estate is a prudent measure to ensure that one’s personal investment strategy is well-rounded and generating cash flow. Investing in a Limited Partnership is a great way to start out and begin to understand the nuances of investing in commercial property. Dividends tend to be distributed on a scheduled basis, risk is mitigated, and deal execution and management is put into the hands of (hopefully) a well-respected General Partner.
Form has handled many different types of transactions and client needs including sourcing equity on behalf of developers and General Partners. Please contact us to discuss all of your commercial real estate investment inquiries.
