bSFD9Xhw

What’s the ‘ALTERNATIVE’…
To stock market volatility and uncertainty for 2019?… CRE?

Many people and investors are feeling some pain and angst as they are experiencing the increased volatility in the global equity markets.  Many investors perceive uncertainly about so many investment factors.  Some of these investors are nervous about return expectations for their traditional investments for next year. As investors set their investment plans and strategies for 2019, some are concerned about the level of volatility in traditional investments (stocks, bonds and mutual funds) that they might have to endure to achieve their return goals.

To diversify away from the recent volatility, correlation and uncertainty of traditional investment in stocks, bonds and ETFs, there may be an ‘ALTERNATIVE’ for individual investors to consider. . .

ALTERNATIVE?… Income Producing Commercial Real Estate?

 

Rewind to December 2017 and return expectations for 2018

 

Before evaluation of investment plans for 2019 is discussed, it is worth while taking a quick look back to late December 2017, when investors were setting their investment plans for 2018.  As 2017 was coming to a close, the US equity markets were completing a strong performance year with the S&P 500 index gaining 21.8%, the Russell 2000 gaining 14.6%, and the FAANG stocks: Facebook (+53%), Amazon (+56%), Apple (+46%), Netflix (+55%), Google (+33%). There was a new tax cut for business passed by Congress in late 2017, so some investors felt that this momentum could continue into 2018, and they could set a PASSIVE investment strategy to investing in indexes, ETFs and other traditional portfolio options like stocks and bonds.  A few investors and advisors even said: “Set it and forget it” with regard to PASSIVE investment strategies for 2018.

 

Coming off a strong 2017, and expecting the positive market momentum to continue in 2018, some investors were less interested in making investments into income producing CRE, with return profiles of 6% to 12% (based on asset growth and income, produced by the asset).

 

2018 returns did not play out to the expectation of many investors.  The S&P 500 is bouncing around a return of 0% for 2018, as year-end nears.  Equity indexes have experienced much more volatility in 2018 compared to 2017, causing nervousness about return expectations for 2019.  Meanwhile many Class A CRE assets produced returns of 6%-12% in 2018, with much less volatility than those traditional assets.

 

Setting investment objectives and goals for 2019: Assessing Uncertainty for investment return factors:

 

There is no certainty to investment return.  Each investor must determine their own risk tolerance first, and then set their investment return goals based on their tolerance for risk.  The hard part for many investors is how to assess risk and set expectations for potential return.  Looking forward to 2019, many investors are concerned about what the certainty may be for both growth and income (asset price growth and dividend/income returns) on their investments for traditional investments (Stocks, Bonds, ETFs)

 

Alternative Investment option? Income Producing Commercial Real Estate?

 

For some investors, there may be an alternative investment option that could be of interest for investors looking for non-correlated investments to traditional investments, with potentially less price volatility in the short term.

 

Income producing commercial real estate assets

 

These types of CRE assets typically have existing cash flow being produced by rental income from tenants. Depending on the asset class and market location, the cash flow to investors might be in the range of 5%-10% depending on the leverage and financing structure of the asset.

 

The risk to the investor is the certainty of the cash flow coming from rental income of the asset.  A Class A commercial office building, with over 95% occupancy, with leases from multiple credit worthy corporate tenants, that do not expire for at least 5 years, should have more certainty of cash flow from the asset compared to the cash flow to investors from traditional assets: stocks, bonds, and ETFs.  Also, there can be much more short-term volatility to traditional investments that trade on an exchange, compared to a Class A Office building with high occupancy that does not have its NAV traded daily on an exchange. Class A commercial office assets are long term investments and thus do not have their NAVs priced every second or every day.

 

2019 investment strategy options

 

Some investors can evaluate, analyze and review investment options for 2019, and then gauge what type of risk/certainty there may be to achieve returns that may be derived from dividends/interest and asset price gains of a Class A commercial office building. Then, compare that risk to traditional investments.  Those investors can then compare the certainty/uncertainty of traditional investment returns and make their own assessment for the likelihood of achieving total returns of 0%, 5%, 10%, 15%+??? . . . or losing money.

 

If some investors are concerned about potential volatility in their traditional investments, and uncertainty for returns in 2019, they may want to evaluate and consider an ALTERNATIVE investment option: Income producing commercial office real estate assets.

 

If an individual investor decides to evaluate and eventually invest in income producing CRE assets and funds, the investor should make sure that their investment capital is going directly into the asset or investment vehicle with zero slippage or commission to invest into that asset or investment vehicle.

 

Welcome to the Investment Revolution!

 

Investing in KBS Growth & Income REIT includes substantial risks. These risks include, but are not limited to: the possibility of losing your entire investment; no guarantees regarding performance; upon sale or distribution of assets you may receive less than your initial investment; fluctuation of the value of the assets owned by KBS Growth & Income REIT; lack of a public market for shares of KBS Growth & Income REIT; limited liquidity; limited transferability; reliance on KBS Capital Advisors LLC, the REIT’s advisor, to select, manage and dispose of assets; and various economic factors that may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Shares of KBS Growth & Income REIT are not suitable for all investors. Investors should read and consider the PPM carefully before investing.
KBS Direct makes no representations as to the appropriateness of an investment in KBS Growth & Income Real Estate Investment Trust for ERISA plan fiduciaries and IRA owners and no investment advice is being provided. ERISA plan fiduciaries and IRA owners should consult with their own advisors and counsel before making an investment in the REIT’s shares. This is not an offer to sell securities. Offers to sell, or the solicitations of offers to buy, any security can only be made through a private placement memorandum and other official offering documents that contain important information about risks, fees and expenses.
Securities offered through North Capital Private Securities (NCPS).

 

DIY Portfolio Graphic_v2-01-2

Building a Do-it-Yourself CRE Investment Portfolio

Investing into commercial real estate directly is becoming a new wave for investors looking for an alternative to traditional investing into stocks and bonds.  Direct access to commercial real estate, and technology at the sponsor level, has created online accessibility to detailed information about real estate assets, sponsors and potential investments.

 

Why are many investors looking to invest directly into commercial real estate?

 

With the equity and bond markets displaying recent volatility, the traditional investment markets may not present the most interesting risk/reward investment opportunities for some investors.  Many investors are turning to alternative investment options, and specifically to investments into commercial real estate. Real estate investing is generally for the longer term and is typically not liquid in the short term.  The longer-term hold period for a CRE investment may reduce the volatility of the investment as prices of buildings and CRE investments do not get marked-to-market every second as traditional investments do in traded markets.  Investing into CRE is attractive to some investors because it is a diversification away from the potentially volatile traditional markets, and may be  more predictable for cash flow purposes.

 

DIY Investing: Direct access to CRE investment information 

 

So once an investor has decided to join the revolution of investing into commercial real estate directly, how should one consider building a portfolio of multiple investments into various different types of CRE?

 

First investors must gather information on CRE markets and understand where the opportunities are for different types of CRE investments. Part of this process is evaluating the risk/return profiles that are interesting to the specific investor.

 

The first question to be asked by an investor: Are you investing for cash flow for immediate yield, or are you investing for capital gain at the end of the investment?  When a CRE asset is producing sustainable cash flow from rent collected, the asset can then distribute that cash flow to investors, once expenses and debt service is covered. CRE assets with strong cash flow and attractive distribution rates, tend to have less upside to investors at the end of the investment, unless the market for that asset improves over time. The other option for investors is investing in CRE assets for growth and potential capital gain at the end of the term for the specific investment.

 

Below, you will see a pyramid of various investment returns and profiles.  Don’t yield shop! BEWARE of the temptation to “Yield Shop”.  A sponsor may display a high yield or target IRR for an investment, but that means nothing. It is often just a projection by the sponsor.  Investors must understand that to reach for higher return targets, there is significantly more risk involved. Also, cash flow and distributions to investors can be very different depending on which type of CRE investment is made.

 

 

At the bottom of the pyramid, in the green section, investors can evaluate return profiles of 5% -9%. These types of properties are more established buildings with existing tenants and cash flow. These types of assets can be Class A/B buildings in Office, Multi-Family, Industrial or Retail. The end investor is typically looking at these types of investments for steady cash flow and lower risk to the value of the asset. Questions must be asked by the investor about tenant and rent sustainability; location risk, and leverage and financing risk to sustain the cash flow. There may be upside potential in the assets if the specific market for that the asset appreciates in value, and another buyer will pay a higher price than the entry price for the current investor.

 

The middle part of the pyramid, in the blue section, investors typically focus on value-add real estate where the sponsor and investors are going to potentially enhance value by making significant upgrades to the asset. These upgrades cost money and thus there is often very little, or any cash flow distributed to investors in the first few years of ownership. The goal is to enhance the value of the property and then lease up that property to a sustainable level so that it can be sold to another type of buyer in the future. Thus, the gain to the investor comes when the building starts producing cash flow and is eventually sold at a higher price above its acquisition price.  The risk to investors is that if the cost of the value-add takes longer than expected and if the expected tenant lease rate increases are not achieved it could impair the  the value of the building on resale.

 

The top of the pyramid, in the yellow section, investors are striving for a much higher return profile and thus are taking significantly more risk to try and achieve this return.  Typically, the +15% return profile is for ground up development projects, which includes new construction or a complete teardown of an old asset and then new construction on the lot. There could be no cash flow for years as the project is built. These types of projects can include: office, multi-family, industrial, retail, hotel/leisure/lodging and residential. Investors may achieve gains in their target ranges if the assets are sold to new buyers or refinanced at levels significantly higher than the development costs and financing costs of the project.

 

Building a DIY CRE portfolio:

 

The pyramid is used to suggest that when building a CRE investment portfolio, that a larger amount of capital is allocated to the return profile with a more predictable cash flow from sustained assets: the bottom of the pyramid in Green.  This way an investor can have a base to the CRE portfolio of both cash flow and some potential upside growth in the value of the CRE.  The value-add section of the portfolio will have a smaller allocation compared to the ‘cash flow’ base of the portfolio because it is taking on more risk than the bottom GREEN section, and the cash flow will not be as immediate in the first 1-3 years of the investment. Finally, the YELLOW SECTION of the allocation will be even smaller, as the risk is even higher than the previous 2 portions of the pyramid.  The YELLOW SECTION of the allocation could have very little or no cash flow until the project comes on line.  Market conditions may change for the worse by the time a project comes on line, and thus investors must be prepared for this risk.

 

A blend of all these tranches of the CRE pyramid is a potential way to begin building a CRE investment portfolio for the DIY investor.  In the end it comes down to the risk profile of the investor and what the goals are for building an alternative investment portfolio with CRE as an allocation for yield and/or growth.  Evaluate the type of CRE asset, the sponsor, the location, the risk to cash flow and value, and the exit plan. Work with sponsors where there is total transparency and the ability for the investor to gather as much information as possible on the investment options.

 

Welcome to the DIY CRE INVESTMENT Revolution.