In Part III of our investment series, it’s time to focus on questions to ask yourself prior to putting capital towards a commercial real estate investment. We’ve already talked about questions to ask about the sponsor in Part I, as well as questions to ask about the investment in Part II. Now we must tackle the tricky issue of what to ask yourself prior to investing. In today’s post we’ll cover things like what percent of your income should you invest? Are you looking for growth or income? To effectively put capital towards an investment, you need to take an introspective look to make sure you’re ready.
Questions to ask yourself
Is this your first investment? What is your prior investing experience? Private-side commercial real estate investing isn’t for everyone. You have to remind yourself that you are not playing the stock market. Typically, once your investment is tied up in an investment, you might not get it back for 2, 3, 4 years or even longer. While real estate doesn’t necessarily feel the same effects from tumultuous stock market rides, you do need to know the market. Research cities, locations, and industries – try to become an expert yourself, but if you don’t go that route, ask the sponsor.
How much can I afford to lose? Research has shown men and women look at risk tolerance very differently; risk tolerance is a psychological term, and men are nearly always more “risk tolerant” but investments are likely being made by a couple, so it is important for a couple to be able to look at things the same way. A less common term, but far more appropriate, is Risk Threshold - this meaning how much of your portfolio can you afford to lose; wherein your lifestyle, quality of life, or goals will not be adversely affected if you lost the investment?
Real estate investments can be very secure, produce good income and outsized returns, but in contrast to the public markets where you can sell and salvage some of your investments if things are going dramatically wrong, you do not have that luxury with private investments. If things are going wrong, you are in it until the end and you could lose ALL your investment. So, as the old adage goes, hope for the best but plan for the worst.
Am I eligible to invest? Different types of investments come with different types of requirements. Places like the stock market or equity crowdfunding allow for almost any individual to investment in an opportunity (occasionally with ceilings). Every investment that Northstar offers, is strictly for accredited investors. This means that an individual or couple must fall into one of three categories: 1) an individual with annualized income of more than $200,000; 2) a couple with annualized income of more than $300,000; 3) net worth excluding a primary residence of more than $1,000,000. If you do not fall into a category making you an accredited investor, there are still many real estate opportunities on equity crowdfunding platforms.
Are private investments right for me and my family? Most private commercial real estate investments only accept accredited investors; if you do not have a net worth in excess of one million or annual income of $200,000 then private real estate investments might not be appropriate for you as they are illiquid and often considered high risk. If you think you might need the funds within 3-5 years, private investments might not be right for you.
What percentage of my investable asset do I want in real estate? This is a tricky question that is completely dependent on your net worth, liquidity requirements, risk threshold, and investment goals. An important aspect to consider is the amount of leverage the various investments you chose have; from a risk mitigation perspective, the less leverage being used, the more you can allocate. Investment guidance has evolved over the last decade and now many of the thought leaders and brokerages support an allocation of 10% or more. The Yale endowment, which has similar goals as a retiree (i.e. capital preservation and income generation being the priorities), has about 10% of their portfolio in real estate not including the real estate owned by companies they are invested in.
Once you have an idea of your total commitment to the asset, the next thing to consider is the level of diversification. There are several key areas that diversification is important:
Product type: Multi family, office, retail, industrial etc.
Geography: gateway markets, secondary markets, foreign markets
Strategy: income, growth, equity, debt
Sponsors: local developers, national developer.
Structure: direct investments, partnerships, funds
How long can I keep this money tied up? A big knock against real estate investing for some people, is the fact that your money is not liquid. Unless you’re in a fund structure where you can typically get your investment back in 60 or 90 days or a REIT that has daily liquidity, your money is typically tied up for several years. Occasionally you might be able to sell your private securities, however, it will likely be at a terrible discount. Ask yourself, are you okay with not having access to your investment for 2, 3, or 5 years? Delays in real estate can happen, so always be prepared that your funds might be tied up for a bit longer than expected.
Do I trust the sponsor? When it comes to investing and real estate, it mainly boils down to trust. Even if you throw everything out the window, what does your gut say? Does the person selling you an investment have a strong background? Do the numbers make sense? Does the sponsor have a long track record? Take a look at Parts I and II of our investment series to see what questions you should ask prior to investing.
Do I feel good about the opportunity? Have you ever invested in a stock, then the next day read a negative article on the company, prompting you to overreact and sell? Sometimes with investing, you get cold feet. It’s a natural feeling. With private-side investing, once a subscription agreement is signed, you typically don’t have the ability to back out or sell your shares. Because of this, you have to feel incredibly confident about your investment. The good news is, real estate isn’t nearly as volatile as the stock market, and good pieces of land almost always tend to appreciate in value.
How do you feel about the asset itself? Do you want pride of ownership or simply want safety, income, and growth? Today there are a lot of marijuana real estate opportunities, how do you feel about that? How about gun manufactures, tobacco fields, low income housing, etc. These are hard, personal questions that you should ask yourself.
Will my significant partner/spouse feel the same way? Most people who are in a serious relationship quickly realize that questions surrounding money are joint decisions. When it comes to investing, it’s important that you take into account what your significant other thinks. If a poor investment decision is made by one individual, then they will have to deal with the consequences.
Hopefully this blog post, along with our prior two (Questions to Ask the Sponsor, and Questions to Ask About the Investment) will help provide you with helpful information if you’re thinking about investing in private-side commercial real estate. We encourage you to research potential opportunities, and ask any number of questions. If you’d like to see what opportunities Northstar has available, then please visit https://invest.northstarcommercialpartners.com/.
If you have any questions, please do not hesitate to email our Investor Relations department – they typically respond in less than 24 hours. You can reach them at InvestorRelations@northstarcp.com.
This post was written by Northstar’s Director of Equity, Danny Mulcahy.