If you’re looking for a direct real estate investment (R2) with no day-to-day management responsibilities, an equity transaction may be a good choice for you. Here are a few things you should know before making your investment decision.
1. Sponsor’s Experience
Experience comes in many shapes and forms: years of experience, assets under management, local market experience, specific property type experience, and more. It is important to understand the qualifications of a sponsor prior to investing alongside one in an equity transaction.
While investors typically provide the majority of equity capital, sponsors also contribute their own risk capital as equity for a transaction to have “skin in the game”. Investors should generally look for sponsors willing to contribute 5-10 percent or more of the capital for the project.
A few common structure types are limited partnership (LP), Joint Ventures (JV) and common shares of the corporate entity holding title to the property. In Canada, LP units are the most common type of investment in Commercial Real Estate. In LPs, two or more investors join together to manage an investment. The general partner (GP) leads business decisions and assumes liability for debts. The other partners—the limited partners (LPs) —have little control over regular business decisions and operations, are not liable for debts, and participate passively in the gains or losses produced by the project.
4. Direct (R2 for e.g.) or Indirect (REITs or MICs)
Investing directly and individually into the property-holding entity has its distinct advantages (primarily, avoidance of fees and expenses). Its secured with underlying real estate most importantly.
When investors all pool into one entity like a REIT or a MIC, they are subject to market volatility, higher fees and have to trust the management “blindly” that they will do the right thing. An investor does not know which property they have invested in and have no recourse to any property in the case of a bankruptcy of the REIT or the MIC.
It is important that investors understand how much of their investment is going to be invested in the actual property (vs. other transaction costs) and what are the ongoing fees that they will have to pay throughout the life of the transaction.
- Acquisition fee – a fee the sponsor charges to find a property, perform due diligence and complete the acquisition
- Asset management fees – a fee the sponsor may charge to manage the asset
- Property management fees – a fee paid to a professional property management company to run the day-to-day operations of the business
- Disposition fee – a fee the sponsor charges when the property is sold
Leverage, with today’s ultra low rates, in commercial real estate is a must. However, it has to be of right kind in terms of LTV, Amortization, Rate and Term.
Even if passive investors don’t have direct management responsibility for the property, certain expenses, such as depreciation and certain operating expenditures, may be tax deductible. In limited partnerships, general and limited partners individually report and pay taxes on their share of the profits. Limited partners can also write off some of their personal expenses (that are incurred to against this income.
Commercial property investments are safer than many other investments and provide a more predictable fixed income stream, if done right.
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