Your investment stake in commercial real estate varies based on your use of said real estate. If you occupy your business address, you’re an investor of sorts but generally classified as an owner occupant. Conversely, if your monthly income relies on a rent check from commercial real estate purchases, you are an investor-owner.
Today, I thought it would be fun to dissect the sundry sorts of investors we encounter in the commercial real estate profession. So, in no particular order, here it goes.
It’s important to understand that an investment is made in a location by the owner of the business. Simple, right?
Not to confuse things, but generally, owners whose businesses live in the buildings they own have an investment structure. Most typically, the proprietor of the company creates a limited liability company – or an LLC. Title to the real estate is then vested under the name of the LLC. Occupying the parcel is the business.
Frequently, the business has different ownership, for example, a Sub Chapter S Corporation. Although the LLC and the Sub S have synonymous underlying principals, they are two separate entities.
Therefore the Sub S pays rent to the LLC.
The LLC is the investor and the Sub S is the tenant. Whew! As you can gather, many places to invest money exist for a small business. Machinery, equipment, customer acquisition, and new employees all compete for the investment dollar. Considered must be the return on investment for all of these opportunities to grow the business.
Specifically, if I buy a new machine and spend X amount of money, will sales grow proportionately and how will a purchase of my premises affect the expansion of my enterprise?
Private capital investors
Generally defined as the use of your own money, in this case dollars generated from the investor’s hip pocket. Certainly a bank may have been used to finance the real estate purchase but the down payment came from a non-public source. In the case above – an owner occupant – consider what happens if the business that occupies the building is sold but the commercial real estate is retained. Now, that owner-occupant becomes an investor-owner. Before, he controlled the tenant — an operation he owned.
Now, he simply owns the real estate. We have a client who parlayed this method into a fairly substantial commercial real estate portfolio. Acquired were the properties – in different locations – that his company occupied. Amassed were a dozen or so buildings. He then sold the business, struck long term leases with the new company for all of his properties and voila! He is a private capital investor. Before, the operation he owned made money and paid him rent – a daily double. Now, the returns are only from the rental income.
Institutional capital investors
Broadly defined as the use of other people’s money – OPM – institutional capital can vary widely from friends and family to the State of California’s Public Employee Retirement System – CalPERS. An institutional investor uses these funds to buy and manage commercial real estate. Clearly, different levels of sophistication are needed. Regardless, a tenant must pay rent in order to generate a return on the invested proceeds.
Occasionally, these institutional investors will package their holdings and create a publicly-traded company – known as a Real Estate Investment Trust – REIT. Stock is available to buy and sell through a stock exchange – NYSE or NASDAQ. As every share of stock is valued the same, easy transition in and out can transact. Your dividends are generated from a small sliver of rent from the underlying buildings. Quite creative!
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at [email protected] or 714.564.7104.