To market commercial real estate products to high-net-worth individuals, you have to know exactly who you are marketing to, according to wealth management advisors and CPAs.
Investment  objectives and appetites for risk vary widely among this type of investor. Experiences range from those who have made their fortunes in real estate and are capable of managing their own buildings to relative novices who may want to maximize their returns but need the guidance of a professional. Others look to real estate as an asset key to estate planning for transferring wealth to their heirs. As a result, there is no “one size fits all” approach for dealing with high-net-worth investors, although there are some guidelines that financial advisors and family offices keep in mind when dealing with these types of clients.
Regardless of the approach, today may be an opportune time to pitch commercial real estate products to high-net-worth investors, according to Christopher K. Cooper, principal and managing director in the Southern California  office of Avison Young, a national commercial real estate firm. With the still-volatile stock market, real estate offers a stable investment alternative in the form of a hard asset. Plus, for investors who need additional sources of income, it can provide current cash flows, which many stocks do not.
The institutional investors’ run on the sector in the years post-recession also gave people the idea that there are bargains to be had. “Real estate was value-priced over the past several years,” says Steve Cohen, executive vice president with Sabadell United Bank, a Miami-based bank that operates a wealth management division, Sabadell Bank & Trust. “There were good properties trading below replacement cost.”
Yet commercial real estate can also be a hard sell, according to Jeffrey S. Buck, principal in the Atlanta office of Diversified Trust, a wealth management firm with more than $5 billion in assets under management. In spite of the fact that most of Diversified Trust’s clients are highly sophisticated investors, the first response when the topic of commercial real estate is broached tends to be, “‘But I already own a house and a vacation home,’” Bucks says. “One of the conversations we have with them is that what we are talking about is not that.”
Unlike stocks and bonds, commercial real estate also requires intensive management and in-depth expertise “or else you can see the cash flow of the investment decline rapidly,” says Sabadell Bank’s Cohen.
Meanwhile, declining cap rates have made it difficult for many private investors to find deals  that pencil out for them, notes Liz Miller, CFA with Summit Place Financial Advisors LLC, a Summit, N.J.–based wealth management firm. The only real estate investment her clients made in recent months involved a commercial property in Panama. Most have been trying to shore up occupancy levels at properties bought prior to 2008.
In the years since the Great Recession much of the high-net-worth money has been diverted to REIT stocks, which outperformed the broader stock market from 2009 through 2012, hitting their peak last year. In 2012, the REITs in the FTSE NAREIT U.S. REIT series delivered total returns of 20.14 percent. But REITs have been hit hard by the recent interest rate spike, Buck says, since their dispositions and acquisitions during the current real estate cycle have been in large part driven by yields. “That’s a dangerous thing when there is concern that rates are going to rise.”
Many Faces of Private Wealth
The amount of commercial real estate that high-net-worth investors carry in their portfolios can range from zero percent of total holdings for people who know nothing about the industry to approximately 70 percent for those who are experienced enough to manage their own properties, says Cooper. In between are individuals whose real estate investments make up from 25 percent to 50 percent of their portfolios. These people can be 1031 exchange buyers or small multifamily building owners.
A lot of high-net-worth individuals’ investment preferences “have to do with their age and the age of their family in terms of how much risk they want to take on,” says William H. Winn, president and CEO with Fortus Property Group, an Irvine, Calif.–based firm that seeks retail acquisition opportunities on behalf of high-net-worth investors. “As they mature, they want to do something a little less risky on the real estate side. Also, we need to assess if they are investing for cash flow or appreciation.”
The amount of cash an investor has to spare also plays a role. The wealthier individuals can afford to bet on multitenant properties, which involve higher risk but offer higher rewards. Meanwhile, someone with more modest means may be best served by buying up multiple single-tenant properties to diversify and minimize risk.
“We do find that a lot of high-net-worth families go to [single-tenant] retail because the expense burden is mostly on the tenants and the tenant improvements are lower cost,” notes Winn. “Office is probably the most difficult, just because of the extensive leasing, tenant improvements and then you have the gross leases, and that puts the expense risk on the owner.”
New on the Scene
Being risk-averse, investors new to the real estate space will prefer funds that concentrate on stabilized assets, with yield expectations in the 6 percent to 7 percent range, Cooper says. And they won’t mind having their money tied up for the long haul, with return horizons of 10 years or more.
New-to-the-market investors and those in the estate planning stage may also be concerned with a fund’s leverage levels, according to Steve Cohen. “Someone who will leverage their portfolio with 50 percent debt is going to give you a better sense of comfort than someone who will put on leverage of 60 or 70 percent,” he says.
In fact, some of these individuals may come to a wealth manager’s office expecting to invest in core assets in primary markets because they perceive them as the safest bet, says Buck. But Diversified’s staff tries to explain that given their investment objectives and today’s environment, they may be better off buying into value-add.
Buck brings up this example as a typical value-add play: One of the multifamily management firms in the fund portfolio has bought a somewhat dated apartment building in an infill location in Atlanta, a market it previously viewed as unattractive.
The rents at the building were far below those reported at other multifamily properties in the neighborhood. But after the management firm spent a modest amount of money to upgrade kitchen cabinetry, landscaping and other building features, it was able to achieve full occupancy and much higher rental rates, eventually selling the asset at a profit.
“We are fully expecting for this to take 10 years to realize [our investors’] returns,” Buck says about the fund of funds. “We’d be happy with returns in the low teens and assets that have low correlation to the public market. Diversification is important, by property type, by geography and then, of course, by manager and strategy.”
Middle of the Road
Investors who play in the 1031 exchange space prefer long-term holds as well, but they do need stabilized properties to get steady incomes and minimize risk, says Cohen. Their return targets tend to be in the 5 percent to 10 percent range and this is a segment of the market where credit tenants and long-term leases are highly prized. Single-tenant retail properties are particular favorites, including Walgreens and CVS stores.
In fact, 1031 exchange buyers may be willing to pay a premium for a quality asset because that’s still preferable to paying income tax on their last investment, Cohen says.
The more adventurous of the 1031 exchange players may be willing to buy smaller strip centers with four or five retail tenants or multifamily buildings, which are perceived as safe because of the steady demand for housing.
“Even if it’s an apartment building with just eight or 10 people, you have eight or 10 people who can call you in the middle of the night because their toilet got stopped up,” Cohen says. “You need someone in the office to run the leasing, someone to collect the payments and do maintenance.”
On the far side of the spectrum are those investors who feel comfortable enough to buy properties directly, even without the tax benefits of 1031 exchanges. These individuals will often bypass the wealth management firms altogether and work directly with real estate brokers  instead, Cooper says. Depending on how risk-conscious they are, they may seek assets that deliver returns from 10 percent to 20 percent, and might be willing to acquire value-add properties, with the plan of repositioning them and selling within a three- to five-year window.
“That’s a much more sophisticated play, but we have clients who do it,” Cooper notes.
These investors tend to look for acquisitions through off-market deals, since they want to preserve cash and avoid bidding wars. They will gravitate toward the more “management-intensive” but higher yield asset classes, including office and industrial buildings, as opposed to multifamily properties.
It’s fairly common for this type of investor to buy a nonperforming note on a small retail or office building and assume control of the asset post-foreclosure, notes Cooper. At this point, they can bring in a co-investment partner, reposition the property within a two- or three-year time frame and sell it at a profit.
Cohen notes, however, that it’s important to alert clients to the fact that this type of transaction does not qualify as easy money. It takes investment acumen, knowledge of market conditions, on both the macro and the micro level, and management expertise—facts that have to be driven home.
“I think the most common mistake is when a high-net-worth individual thinks that this is an easy business,” Cohen says. “This could be a very successful doctor who hears from his patients how much money they make in real estate and decides to do it himself or a lawyer who hears it from his clients. There is a lot of money lost in real estate. People don’t surround themselves with professionals who know the business; they try to do it themselves.”