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BRIAN ESTES — Preferred investment property types of high net-worth investors


In my last article, published in January, I addressed why high net-worth investors (HNWIs) should allocate to commercial real estate (CRE) as opposed to other alternative asset classes.  Those reasons included were: preservation of wealth; cash flow; appreciation; tax purposes and estate planning.  Although I went into detail in each of these reasons I didn’t touch on the types of properties that are preferred by HNWIs.  After writing the previous article I received many calls and emails from investors who were curious which property type was best.  Every situation is different and every investor’s circumstances may dictate how much risk tolerance they can take; however, experience is a big factor in this decision.  According to National Real Estate Investor Magazine (November/December 2018 issue), there are a few property types that stand out as the preferred property choice for HNWIs.  They are in this order; Multifamily; Industrial and Medical Office.  Most investors who have knowledge and experience in commercial real estate know there are a hosts of other property types such as: office buildings, hotels, self-storage, large shopping centers, student housing, senior living, land and a myriad of other sub-property types.  Several articles, such as the one listed above, lists multifamily and industrial as numbers 1 and 2, respectively, but there is disagreement on the third ranking.  Again, the National Real Estate Investor listed medical office as number 3; however, based on my twenty (20) years of experience helping HNWIs purchase investment properties, small retail centers (strip retail) should be number 3.  Below I have summarized why each of these property types might attract HNWIs who purchase investment properties in the $1 million to $5 million range and why they are consistently ranked as a favorite.

Ranked Number 1 is Multifamily.  There are many reasons Multifamily ranks number 1.  First, is it is an easier property type to transition from investing in single-family homes and/or small residential investment properties.  It’s no secret that most commercial real estate investors started their investing career with small residential properties and it’s only natural to continue to invest in larger properties.  In my experience most large apartment syndicators were once renting single family homes.  Another reason multifamily ranks number 1 is easier access to long-term, non-recourse debt.  Many HNWIs like to invest equity in larger projects; however, personally guaranteeing a mountain of debt is not an option to some investors.  In addition, the amortization periods that exist on these types of agency loans can be 25 to 30 years.  Additionally, predictability of cash flow is another reason this is the preferred asset type.  These properties tend to be very predictable if underwritten correctly, including reserves for replacements.  Multifamily cap rates in 2017 and 2018 compressed slightly even though there were interest rate hikes.  The demand for quality multifamily properties is overwhelming and the prices and cap rates reflect this in the overall investment market.

Ranked Number 2 is Industrial.  Industrial is a broad label for many property types.  Industrial could refer to large industrial warehouses, manufacturing facilities, distribution facilities, research & development facilities, etc.  Most industrial properties that are favored by HNWIs are multi-tenant flex warehouses.  These properties range from 25,000 to 50,000 square feet and house small to medium size companies.  The properties usually feature anywhere from 25% to 50% of improved office space with the remaining being in warehouse and/or showroom.  These types of buildings may be located in urban or sub-urban areas and rarely in traditional heavy industrial parks.  Similar to multifamily, cap rates for this property type, as well as, other industrial properties have seen some compression even though interest rates have risen and future increases are imminent. Obviously, the effect of Amazon and other online retail companies have drastically changed the way retail tenants are doing business.  Many of the traditional community and power center tenants have either reduced their footprint, leaving landlords with vacant space or have filed for bankruptcy protection.  The industrial sector has certainly been a benefactor as the surge in online sales have created strong demand for well-located storage and distribution centers are quickly being leased.

Coming in 3rd is Small Retail Centers.  Again, this property type can be further described as “strip retail”.  These properties are located in proximity to large neighborhoods and residential housing on busy corridors and intersections.  Small retail centers house necessity and service based retailers and businesses that serve the neighboring residents.  Most investors feel these type properties and tenants are somewhat “internet proof” as most of these tenants are less affected by the sharp increase in online sales.  In my experience, in most tertiary markets, I would have to believe this could be number 2 for HNWIs as this is the most requested property type from buyers.  Unfortunately these properties are difficult to find if you are only looking in A and B+ sub-markets and they don’t trade as often as most other types of retail investments.  It wasn’t terribly long ago these properties were not favored by national lenders as they tend not to be “anchored” by a regional or national tenant.  However, as the great recession played out, many of the anchors either went of business or consolidated with other businesses leaving landlords with a difficult and challenging space to fill.  Additionally, these type properties are appealing to a wide range of tenants and are not limited to just “retail”.  There are a hosts of other users such as insurance, real estate, investment advisors and other users that might be considered “office” that prefer to be in these locations.  The recent uptrend in fitness facilities have backfilled a lot of retail spaces in these type properties.  Regardless, the strip retail location seems to always have demand due to their location, access and proximity to customers.

In conclusion, there is not necessarily one “right” property type for all investors, especially HNWIs.  As mentioned previously, experience plays a great deal and that is why multifamily tends to always be the number 1 choice.  However, other investors who have been successful in small retail probably feel safer sticking to what they know and understand.  Most HNWIs investors should attempt to stay away from properties that have a high tenant improvement requirements such as office and larger retail centers.  As noted in the above property types; multifamily, industrial and small retail centers have very low ongoing capital requirements.  Yes, every so often the multifamily or retail center will require exterior capital improvements, but you are not consistently reinvesting in tenant improvements to improve occupancy.  Larger private equity firms and REITS are more suited to purchasing multi-story office buildings and larger community centers where spending $15 to $30 per square foot is common when re-leasing space.  Overall, it is imperative that all investors, especially HNWIs should assess their risk profile and create an investment strategy that aligns with their long-term investment goals.

» Brian E. Estes is president and investment advisor with the Estes Group and can be reached at brian@estesgroup.net.


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