Aspiring athletes in any sport look to the professionals as a way to learn and improve their skills and knowledge of their game.
Any left-handed hitter would be well-advised to watch as much video as possible of Tony Gwynn’s swing, a true thing of beauty to all baseball fans. Likewise, an up-and-coming basketball player could learn a lot about situational awareness from watching Magic Johnson come up the court on a fast break. Good athletes learn from the best in their sport and it helps them be the best that they can be, even if they won’t ever be the next Tony Gwynn or Magic Johnson.
As the old saying goes; sport imitates life. So, our analogy also holds true when it comes to real estate investing. In this post we take a quick look at how institutional investors play their game in the hope that we can learn a bit about how to make informed investing decisions that help us achieve our objectives of maximizing yield while minimalizing risk.
Institutional players make up a significant and growing segment in today’s complex and fast-paced world of real estate investing. They are the real pros who have the experience, tools, resources and, most of all, capital at the ready to pounce on a good opportunity when they see one. And right now they have more dry powder to acquire commercial real estate than they ever have.
So, who are they and where do they get the money to invest? Generally, they are seasoned groups of professionals with backgrounds in a variety of commercial real estate specialties who others trust to deploy and manage their money. A primary source of that capital is private and public pension funds who are charged with investing money collected from employees to earn returns that will fully fund the promises made to those employees during retirement. Those who manage pension funds rely on institutional investment firms to invest that money in such a way that generates desired returns and minimizes risk.
While there are variety of other sources of capital for institutional investors, we won’t go into those here. The point is this: they spend other peoples’ money, and that comes with an extraordinary amount of responsibility and risk to themselves. So, it is safe to say that these people are very good at what they do and are among the most respected professionals in the commercial real estate industry.
So, what are institutional investors acquiring today in the industrial sector? The answer is: everything they can get their hands on. Competition is fierce for industrial product for many reasons, but primarily due to low vacancy, lack of new construction and insatiable demand for space from growing businesses, especially in the e-commerce sector. That has rents rising through the roof. Higher rents means higher yields for their capital sources, which is what they are paid to deliver. The potential of higher property values attracts even more capital for further investment, and for now, there isn’t enough property available for acquisition to meet institutional demand. So, institutional investors are flush with cash they are having trouble finding a home for.
Of importance is the fact that most institutional investing is done with a long-term hold strategy. These guys are not investing billions to turn a quick buck. They look for quality properties with excellent rental histories and upside potential for further rental income growth. They also use sophisticated computer models to predict income and expenses over time, rather than simply capitalizing current income. That’s a good lesson to learn for any investor, large or small. Industrial real estate is less speculative than other asset classes like stocks or commodities, and market trends tend to play out over longer time intervals.
Institutional investors are also very careful when it comes to due diligence. They have in-house teams who thoroughly evaluate the physical characteristics, condition and maintenance history of every potential acquisition. This helps them understand how much needs to be budgeted for repairs and replacements of building components during the projected hold period, which is critical in projecting outgoing cash flows during and between tenancies. They are keenly aware of what the impact of lost rental income can be when space becomes vacant and then needs unexpected renovation to attract new tenants. Another good lesson for any investor.
Understanding market trends is another important skill that institutional investors have in spades. They have a keen eye for current market dynamics, and they have as close to a crystal ball as you can get when it comes to predicting trends over time. They are very careful to choose market areas that have strong infrastructures and favorable demographic profiles that will support long-term economic growth because they look at their exit strategy just as carefully as their acquisition strategy before they pull the trigger on a deal.
We encourage you to be just as diligent with your money as institutional investors are with other peoples’ money. Our team can help you in that effort. We have the experience, tools and resources to assist you in evaluating properties for acquisition or disposition, and we are confident we can help you adopt an ‘institutional’ approach to your next real estate investment.