We Study Billionaires - The Investor’s Podcast Network - TIP239: Commercial Real Estate Investing w/ Ian Formigle

Starting point is 00:00:00 You're listening to TIP. All right, on today's show, we have brought back our friend Ian Formigley to talk about investments in commercial real estate. Ian is the vice president of investments at Crowdstreet, and he has completed nearly 300 offerings totaling over $10 billion in real estate deals. Ian is the author of the book, The Comprehensive Guide to Commercial Real Estate Investing, and he's also a contributor on Forbes. So on today's show, we're going to be talking about opportunity zones, interest rates,

Starting point is 00:00:28 and how to value your time during a commercial real estate investing, and he's also a contributor. commercial real estate deal. So without further delay, here's our interview with the talented and for meagli. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, welcome everyone to the Investors podcast. I'm your host Preston Pish, and as always I'm accompanied by my co-host Stig Broderson. And like we said in the introduction. We're here with Ian Formigli. Ian, great to have you here. Oh, Preston and Stig, thank you for having me back. It was a pleasure last time, and I'm super happy to be back on the show today.

Starting point is 00:01:18 Well, it's great having you back on the show, Ian. So let's jump right into the interview. We're talking about commercial real estate. There are things called Opportunity Zones. Talk to our audience about this idea and what they are. I'd say to begin with, Opportunity Zones were created with the passage of the 2017 Tax and Jobs Cuts Act. That's also or referred to as the TCJAA. After Opportunity Zones were created with this act, then the IRS went on to define them as they're defined as economically distressed communities where new investments under certain conditions may be eligible for preferential tax treatment. I think really what that means is that opportunity zones are meant to spur economic development and job creation in what are kind of quote unquote

Starting point is 00:02:03 underserved communities. And by providing strong tax incentives to investors. So I would say that through this act, you know, each state, each individual state was then allowed to go out and designate up to 25% of its low income neighborhoods that met this criteria and they had to do it by June of 2018. So what we saw there was that all 50 states, including all of our territories, went out and made these designations. So the final designated list of opportunity zones, they have an average poverty rate of nearly 31%, which is above the 20% eligibility threshold, and they have an average family income, median income of 59% of its area median. And that was compared to 80% of the eligibility threshold. When we add that all up and look

Starting point is 00:02:49 across the whole country plus our territories, there's about 8,700 certified opportunity zones all over the United States, like I said, and actually almost the entire island of Puerto Rico is included as well. What was interesting to note that when we look across all these 8,700 designated opportunity zones is that they are located in both rural as well as vibrant urban areas. It almost seemed to us when we took a look at it that some states seem to take advantage of the TCJA and designate some of its qualifying census tracks as opportunity zones, even though when you really look at them, they're questionably underserved. I mean, for example, you've got some more noteworthy opportunities across the country that are located in popular secondary markets,

Starting point is 00:03:33 such as Philadelphia, Seattle, Oakland, and Denver. You even have Opportunity Zones that are located in primary markets such as Washington, D.C. If you Google Opportunity Zones Map, you're going to find a bunch of websites that have mapping tools so you can see them all. Anecdotally, I tend to use the one that's provided by the accounting firm Novogradic. It seems pretty easy to navigate. To answer the question about Opportunity Zones on Crowdstreet, yes, we've had two deals so far on the marketplace in 2019.

Starting point is 00:04:02 The first was a ground-out. deal that was a flex industrial building. It was located on the northern edge of the Seattle Metro. The second was a major renovation and repositioning of a dormant hotel in Redmond, Oregon, which is adjacent to Bend, Oregon. Bend, Oregon is a popular outdoor recreational destination that we have here in Oregon. And, you know, we have a third opportunity zone deal in our pipeline right now. That's a ground up hotel development in the Boston Metro. And we expect to have at least a few more opportunity zone deals throughout the course of 2019. For the listeners out there, it's some sounds like traditional commercial real estate the way it was presented, but there's a difference

Starting point is 00:04:38 here. I don't know if you could talk about what is the difference for me as an investor whenever I look at Tunesisone and then more traditional commercial real estate. You are correct in that this is traditional commercial real estate with a twist. I think when we look at Opportunity Zone investing, the key thing to understand between an Opportunity Zone commercial real estate investment versus a regular real estate investment is that it boils down to beneficial tax treatment. And it requires a number of steps to make it happen and continue to make it eligible to happen. So I'll walk you through what that means, but essentially there's six rules of how to make this happen. The first is that you must invest in a property that is located inside

Starting point is 00:05:21 a designated opportunity zone. If it's not in an op zone, it's just simply not eligible. So second, you must invest in that property via a qualified opportunity fund, also known as a QOF. A QOF is essentially an investment vehicle that owns at least 90% of its assets in the form of qualified opportunity zone property, right? That's the actual sticks and bricks of the building. Anyone can self-designate a vehicle as a QOF. You just have to file a form with the IRS and you have to add some additional language into your legal docs, but that's about it.

Starting point is 00:05:55 Third, you must invest with a realized gain into that QOF. And that's important because it's only the gain that is eligible for the tax treatment, not the original principle. So if you think about it, if you bought a stock and owned a stock for a number of years, you maybe invested $100,000. You're pulling out now a large gain. Maybe it's $300,000. So you have a $200,000 gain.

Starting point is 00:06:18 It's the $200,000 that you can roll into a QOF. You actually get to take the original $100,000 and put that back in your pocket. And if you did invest it, it's actually not even eligible for the QOF. So fourth, you must invest in that QOF within 180 days of the date you realized your gain. So I think what we see from investors out there is that you kind of have to have your ducks in a row a little bit. You need to understand that I'm getting ready to realize a gain and I think I can invest in maybe this QOF or that QOF.

Starting point is 00:06:49 So that day requirement is pretty important. So I would like to touch upon one of the things you talked about there with the capital gains. Does it mean that if I don't have, you know, that stock that has been profitable widely or perhaps of losing money in the stock market, would I still be eligible to participate in this? Or would I still be eligible, but it just really wouldn't be worth it if I don't have any capital gains to roll over? That's a good question, because in the key thing is you are deferring a gain. The good news is it can be any kind of gain. Stock market gain is just one type. I mean, literally you could have bought a classic car and sold a classic car. If you have a gain, any form of

Starting point is 00:07:28 gain imaginable is eligible, but that's the key point. It has to be a deferred gain. Any original principle is not eligible for the benefits of investing into a QOF. So, Ian, what are some of the metrics that you're looking for when you analyze an opportunity zone? For starters, key metrics for investing into a QOF, as I mentioned a few minutes ago, they're largely similar to a regular commercial real estate investment, but there are a few exceptions. So I would say the first exception, well, just like any deal, first, evaluate the merits of the deal, just like any other deal that you would look at. As I frequently tell investors, an investment into a QOF is about tax efficiency, but tax efficiency only matters if there's a gain. This entire strategy can only

Starting point is 00:08:14 make a good deal better. It cannot make a marginal deal good. Second, make sure you are investing long-term money. Because as I've discussed, the greatest benefit of an investment into a QOF is really activated after it is held for 10 years. If you withdraw the money sooner, you will lose this key benefit. Third, assuming you are prepared for a 10-plus year holding period, got to make sure that the sponsor of the investment is executing a business plan that is going to meet your requirements and meet the certification requirements. We have seen a few deals come by where the sponsor isn't necessarily committing to a 10 plus year holding period. So it's really important to make certain that all parties are on the same page going in. And then I'd say fourth, analyze after tax returns

Starting point is 00:09:02 and equity multiple and compare them against your other real estate investment opportunities from a risk return perspective. We've done some modeling at Crowd Street and have found that the difference, I would say the potential difference in after tax returns on a ground up real estate deal in a QOF following a 10-year hold could be about 300 basis points on an annualized basis. This would essentially relate to an investment that's a ground-up deal. It targets about a 3x equity multiple over that decade-long hold. And it's similar in context to what I discussed a few minutes ago, even some of the deals that we've had on our marketplace.

Starting point is 00:09:37 So an extra 3% per year of after-tax returns is certainly powerful. But as I mentioned, it isn't powerful enough to overrule a strong investment thesis. It's certainly possible that you might be better off in the long run, paying your capital gains, investing more opportunistically on shorter durations, particularly if you think you may have a need for that capital in less than 10 years from now. So those are some of the key things to I think about when you're contemplating an investment into a QOF. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:14:16 So let's continue to talk about some of the numbers behind this, and thank you for outlining that. Could you talk us through the holding period? I know you briefly touched upon it before. And also the exit strategy that's a little different whenever it comes to opportunity zones. There are some numbers to remember, and the exit is definitely different than a standard deal. So I'll walk through the whole thing. First, there are three numbers to remember when it

Starting point is 00:14:39 comes to with Opportunity Zone investing, and they are five, seven, and ten. I'll walk through what each of those numbers mean. The first two numbers, five and seven, refer to the number of years that you're eligible to defer the gain that you use to make the investment into the QOF, as well as the tax treatment that's associated with that deferral. So, for example, if you hold an investment in a QOF for five years, you are going to receive a 10% step up and basis on the gain. Another way to look at this is that for every $1 of gain, you would have had to pay next year, say, in 2020, it's now a 90 cent gain that you can defer for six years from now. If you hold the investment for seven years, you're going to get an additional 5% step up in basis. So now that $1 of gain is now only

Starting point is 00:15:25 $0.85 of gain, and you're going to pay that gain in 2027. The cut of a dollar, off for the deferral treatment is December 31st, 2026. So to get the full benefit of the deferral aspect of QOFs, you have to invest in 2019. That's part of the reason why there is so much discussion about opportunity zones right now. The third number 10 is actually, I think, the most important number, and this is the number of years that you must hold an investment in a QOF to receive 100% tax forgiveness on any gains inside the QOF. over that period. Think about it. A ground-up development with a 10-year holding period, as I mentioned a few minutes ago, could easily target a 3x equity multiple over that time span. This type of deal would

Starting point is 00:16:13 essentially target a 12 to 13 percent annualized rate of return, which is certainly what we've seen on other ground-up deals with that kind of holding period. So if you were to achieve this type of return, the tax benefit to the investor would be roughly 50 cents on every dollar invested being retained by the investor rather than being paid to the government in the 11th year, which is a lot. So it's really interesting that you say that because I'm sitting here and I'm thinking about the various risks that you might have. For instance, you said that this is new regulation and that's providing new opportunities

Starting point is 00:16:47 that you didn't have before. But what happens whenever that's your true business model is that change and it's based on this new law or this new thing? And so what happens when that political environment changes? And is that a concern I should have? And is it something that I should add into my evaluation of the business? When I think about like the bigger risks that are involved in opportunity zones, I think one of the biggest risks that's sitting there right now is that we have a vast disparity

Starting point is 00:17:15 between the quality and basically viability of different opportunity zones. Certain opportunity zones, particularly some of those that are located in rural areas, are going to be hard pressed to see any discernible bump and indefinitely. intrinsic value as a result of their designation. It's certainly possible that you may see QOF investments be made available in some of these zones, but I would be concerned about the risk of them being really infeasible projects that are now just becoming projects because of an opportunity zone designation, which would really be a false catalyst being used to attract capital. Now, I think there's a couple ways to mitigate this risk. The first way is to look

Starting point is 00:17:57 for projects that were already in motion at the time when the Opportunity Zone designations were announced. And then now maybe kind of quote unquote won the Opportunity Zone lottery. The other way that I think that investors can mitigate this risk of viability is to look at QOF investments that are located and attached to deals that are in urban opportunity zones, particularly those in growing markets, the ones I mentioned before, Oakland, Seattle, Philadelphia, Denver, in Washington, D.C. These types of opportunity zones in these metros are far more likely to see long-term sustainable demand, given that they're anchored by strong underlying fundamentals. These markets have job growth and population growth that outpace the national average.

Starting point is 00:18:44 So anytime that we're thinking about adding commercial real estate supply to a market, we really have to ask ourselves, where's the demand? Is the metro growing? Is there going to be a need for more real estate in the future than there is now? So that kind of almost ties back into the original recommendation of, like, is the deal viable on its own merits? You have a much higher probability of finding that kind of deal when you're looking within more of a major urban market.

Starting point is 00:19:09 If I was looking at a stock, I might be looking at criteria like the price to earnings or the price to sales and whatnot. And then based on my criteria, the best opportunities will prevail. How can I compare that to, say, opportunity zone? Like you mentioned, you know, two, three opportunities perhaps. Is there even such a thing as scanning the market for opportunity sounds? Yeah, it's an interesting question because I do think that there is a rough equivalent in the commercial real estate world to the PE ratio.

Starting point is 00:19:41 And it is essentially capitalization or cap rates. So I'll briefly explain what this means. Cap rates are defined as the net operating income of a property and then divided by its purchase price. It is essentially what I would say is the unlimited. levered yield on the asset. So, for example, if we have a $10 million property and it has $1 million of net operating income, it's a 10% cap rate. You can use cap rates as a metric to compare and contrast similar properties within similar markets and even different types of properties

Starting point is 00:20:12 across the country. I'll give you an example first of comparing similar properties within the same market. Say, for example, you're comparing two ground-up development apartment opportunities that are located in the same neighborhood. And they're both in an opportunity zone. They're going to be built around the same time. They're going to be roughly equivalent conditions. Say you look at the spec of the development. They're assuming similar rents with similar amenities and they have a similar occupancy rate targeted at stabilization, typically 95%. Those two developments should expect to receive a similar cap rate at exit. Then if you look at one of the deals and they say, hey, we're going to build this and we're going

Starting point is 00:20:49 to sell it at a five and a half percent cap rate and that's going to generate my 12 percent return over the decade, while the other one is saying, I'm going to sell it at a 6% cap rate and generate the 12-5, 12 to 13% return over that decade. Now you can discern that there's some difference because one property is assuming a lower cap rate than the other property. Higher cap rate would translate to lower-value, lower cap rate higher value. So now you have to say all things being equal, this property that is assuming that it's going to sell at a 5.5% cap rate really needs to sell for more money all things being equal than

Starting point is 00:21:22 the one for 6%. I'm probably going to dig into the 6% cap rate assumption deal a little bit more because there's something else now in the build cost of the building that is not as attractive as the other deal. That's one way to look at it. Second, it's possible to use cap rates as a mean to compare and contrast different types of properties across all kinds of different markets around the country. Typically speaking, properties that are viewed to have better appreciation prospects are going to have lower cap rate assumptions, just as companies with higher growth prospects tend to have

Starting point is 00:21:52 higher PE ratios than those with lower growth prospects. An example of this would be a ground-up tower development deal in Seattle. That is going to have probably a three to four percent expected cap rate at exit compared to maybe it's a redevelopment of an existing shopping center in Topeka, Kansas. That might be as high as a 10% cap rate. Now, it's not to suggest that one of these deals is necessarily better than the other, but the market is definitely saying two things with this big cap rate discrepancy. One, the apartment tower in Seattle is viewed to have a greater probability of price appreciation than the shopping center in Topeka.

Starting point is 00:22:30 Two, the apartment in Seattle is also viewed to have greater liquidity than that shopping center in Topeka. And however, to get that potential appreciation in liquidity in Seattle, you are going to give up the certainty of income that you could get in Topeka. I really think that what this comparison illustrates is that a final takeaway for investors on cap rates is to think about that cap rates do have strong correlation to net cash flow, or essentially what's left over after paying debt service. So when you look at cap rates, generally speaking, the higher the cap rate, the more income-oriented investment versus

Starting point is 00:23:03 the lower cap rate, the more growth-oriented the investment, and finding both as challenging. It can be as hard as finding a high cap-rate property with high appreciation potential could be as difficult as finding a growth stock, for example, with an 8% dividend. The sum of this is when you're looking at different opportunities of investment within a QOF, they're going to have different expected rates of net cash flow once they're built and stabilized or redeveloped and stabilized. And so the investor can take that in terms of it is a long hold. We don't know if we're going to sell even in 10 years.

Starting point is 00:23:38 If the property can get to a higher realistic stabilized rate of operating net income, it's going to be more income oriented and that would give the investor and the developer. a little bit more flexibility in terms of the ultimate exit strategy. So, Ian, one of the things that we talk about a lot in stock investing is interest rates and the environment for interest rates. And although real estate has its differences, it's also highly impacted by interest rates. So I'm curious how you see the interest rate environment right now and how it might be impacting your investment decisions. Yeah, and they are important. You know, I'd say interestingly, now that we've talked about cap rates, interest rates are a

Starting point is 00:24:19 logical next topic of discussion because those two are correlated in commercial real estate. One data set that we use to gauge value in the commercial real estate industry is to look at the spread between cap rates amongst different asset classes and 10-year treasuries. That spread is going to vary by asset class and it definitely expands and contracts over time. For example, it can be as low as 100 basis point spread for a Class A apartment in a major metro and it can be five to 600 basis point spread for like a hotel in a secondary or tertiary markets. And I generally say that all other asset classes tend to fall somewhere in between. You can find charts on this online.

Starting point is 00:24:59 It's very easy data to find. And the reason that this correlation exists, I think, is primarily for two reasons. First, investors must be compensated for the risk associated with acquiring a property. If there's no spread between the cap rate of a property and the 10-year treasury, then there is no incentive to opt out of getting the risk-free return of treasuries, right? Why would you buy a property and take a lot of operating risk if I can just put my money into treasuries and get essentially the risk-free rate? So that's why that spread has to exist.

Starting point is 00:25:30 And second, real estate investors seek net cash flow at the end of the day when they're pricing deals, so which again, that net cash flow is defined as net operating income less debt service. So in that scenario, all things being equal, if interest rates go up, then, debt service is going to go up, which means that net cash flow is going to go down. As an acquirer is thinking about that and they're looking at leverage, every real estate deal, most of them, a lot of them out there are leveraged. The only way to keep that net cash flow constant in a rising interest rate environment is to price essentially more net operating income into every

Starting point is 00:26:08 dollar spent to acquire the deal. And that's another way of saying that cap rates must go up. So this is the other key reason that you're going to see correlation between interest rates and cap rates. Therefore, in order to maintain a constant risk premium spread over treasuries, you're generally going to see cap rates rise and fall with positive correlation to interest rates over time. It's definitely not perfectly correlated because there are other supply and demand factors at play, but we've seen that there is definitely correlation over time. I would say that when we think about this correlation and now apply it to the current interest rate environment, it's undeniable, I think we can all agree that interest rates right now

Starting point is 00:26:47 are historically low, which would then also mean that prudent assumptions about future interest rates should anticipate gradual expansion over the next decade or so. I think this means that when we look at commercial real estate investments today and we value them in the context of current cap rates, we're going to have to allot for a gradual expansion of cap rates in our underwriting at exit. So, for example, a general rule is to add about 10 basis points per year. So if it's a five-year anticipated hold, we would want to see about 50 basis points of cap rate expansion assumed by the time of exit. I would say that it's interesting to note that most market economists and market participants have been anticipating a rise in interest rates for the past few years, yet the 10-year treasury

Starting point is 00:27:34 currently sits at about 2.5%. This is really where it was in 2010. And I think when you put it all together, it just kind of goes to show that collectively, myself certainly included, we are poor prognosticators of interest rates. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. Vanta automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving.

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Starting point is 00:31:10 I'm curious. This sounds like an interesting opportunity. You talked about a spread of 100 basis points for something like a class A property, which is the safest investment you can think of. But how much is diversified away? Imagine that you would buy into multiple different properties of a lesser than class A property. How much of that risk is diversified away? Basically, I want to have my cake and eat it too, so I want the high return, but I don't want

Starting point is 00:31:35 the risk of, you know, one building, defaulting. How do I think about that? It is a very real risk because if we are investing in one-off properties, we are taking single asset risk. There's just no doubt about it. It's a real risk. Another way to think about this is that the reason that risk is both real and it is elevated relative to other forms of investments,

Starting point is 00:31:59 boils down to the illiquidity of that deal. We cannot simply click a button and sell a commercial real estate asset if we're no longer comfortable holding it. We're in it for the long term. So I think when you begin with that knowledge going in, you have to really think about how you're going to diversify your portfolio and how you're going to essentially already contemplate

Starting point is 00:32:20 and then manage that risk because it's there at its core. Each individual deal, there's no way to diversify the fact that it is illiquid, but there's other ways that we can diversify that risk. So let's talk through some of them. I think there's a lot of different ways to do it, but I'll talk about five ways that I think about it all the time. The first, I would say, is to diversify through lower investment amounts.

Starting point is 00:32:42 You used to have to invest $200,000 or more, typically speaking, to get into a private real estate equity deal. But thanks to the advent of online commercial real estate investing, a lot of platforms out there that are now offering access to deals at a lot lower investment amounts. Now it's like $10 to $25,000. It depends on the platform. So that's one key way. That's one way that I manage that risk myself is that I'm not putting huge sums into one deal. I'm putting smaller sums into multiple deals. The second is to diversify across sponsorship. As I frequently tell investors, don't put all your money with

Starting point is 00:33:16 one operator. There are hundreds, if not thousands, of quality operators across the United States. Look for the experience groups. They have solid track records. And then spread your investment across a multitude of them. From there, you can actually use your investing experience to learn really which are the best of the best. And then perhaps double down or triple down from there on the ones that really outperform. Third, I would say, is to diversify by specialization. Commercial real estate operations are complex.

Starting point is 00:33:44 And not every sponsor can be great at everything and executing on every type of deal. It's just part of what commercial real estate is. And therefore, I would say, look to invest with groups that really do specialize in the proposed asset class. Fourth, I would say, is to diversify across asset classes themselves. We've talked about multifamily. So multi-family can be a great place to begin investing. People have to live somewhere at the end of the day.

Starting point is 00:34:10 But I would also say that multifamily even has its own market cycle within commercial real estate, and that can be different than other asset classes. So I would say, take retail, for example. A few years ago, conventional wisdom was that brick and mortar retail was dead. And that was because Amazon was going to take over the retail world, and this perception led to fear in the market and then led to a drop in retail asset prices. Then, interestingly, we saw a couple of things happen over the last few years. First, you got Amazon acquiring Whole Foods, even beginning to open its own brick and mortar

Starting point is 00:34:45 retail locations. So I think a little bit of the brick and mortar fear of an asset class itself started to burn off. And then second, we've also seen other brick and mortar retail concepts adapt to the online world and in some respects morph into what you might call micro distribution centers. This is the example of retailers who are now making their retail storefront location more of a showroom where they're conducting more and more of their business actually online. So this phenomenon, I think now puts retail into an interesting and arguably undervalued position in the commercial real estate market. What I would definitely think, and I almost look forward to, is that if retail were somehow to get recast as last quarter mile distribution in the next few

Starting point is 00:35:31 years, that Amazon hangover is going to evaporate instantly and pricing is going to spike. So it just kind of goes to show that when you're thinking about asset classes, you can anchor your investment in one asset class, but it certainly pays to pay attention. to other asset classes as well. And fifth, I would say, is diversified by business plan. Some deals are intended to be high risk, high return. A ground-up development deal or a repositioning of an asset definitely fit this profile. And I would say to use a baseball analogy, these are the equivalent of swing for the fences

Starting point is 00:36:03 type of situations. Other business plans entail a stabilized asset where all things considered, things are good, and the plan is to maintain the assets position in the market. This would be an on-base type of strategy. So as investors assemble a portfolio, it's really important to think about blending across these different types of business plans. In essence, if you swing for the fences on every pitch, you have to increase your odds of striking out.

Starting point is 00:36:29 It's just part of the game. So think about that. Take some pitches. It's okay to swing for the fences on some, but then if you do that, then it's definitely prudent to start thinking about an on-based strategy for other investments. So, Ian, one of the things that's very important to any investment, investor is the amount of time they're going to need to add into any investment. So how do you think about the time required to sustain and properly invest in commercial real estate?

Starting point is 00:36:54 Time and effort and strategy are definitely things that we see amongst many investors on the marketplace. I'll start with kind of the most time consuming and kind of heavy brain damage approach and then work it down from there. So one thing that's interesting to think about, we see every day one of the most likely conversions of, is that a lot of, is that a lot of, you know, is a single-family residential investor to a commercial real estate investor in a passive strategy. And the reason that we're seeing that, I would say that buying and owning and operating single-family residential is somewhat like owning a small business. It can certainly be profitable over time. It can be a great way of generating wealth, but it is also very hands-on. You have to buy the

Starting point is 00:37:36 property, you have to lease it, you have to maintain it, you have to manage it, you're going to fix toilets. I can go on and on. So to begin with, a lot of investors that I see in commercial real estate are coming out of that experience and they're looking for a more passive way to begin investing, continue investing in real estate. And they've come out of that process to say, I'm really no longer interested in maintaining my small business of owning an operating single family residential. I want to look for something that will look and feel more like my other investments in my portfolio and invest in a passive format. So that's one way to just from the outset. So from there, I would say that there's three different types of strategies that we see employed by commercial

Starting point is 00:38:21 real estate investors out there. The most time consuming strategy in a passive format is what we refer to as direct investing. That is the picking and choosing amongst individual commercial real estate offerings. This would be akin to investors assembling a portfolio composed of individual stock picks. Just as it is in individual stocks, a lot of analysis goes into selecting a direct commercial real estate investment. When selecting direct commercial real estate investments, investors should consider a host of criteria. That can include strength of sponsorship, asset class, location, business plan, basis, debt terms, and exit assumptions. And we've talked about a lot of those in the conversation today. And I could go on to more, but it's important for investors to understand that given that

Starting point is 00:39:09 relative illiquity that we talked about, investors are inherently taking on more of that single asset risk. And so therefore, it would really reward them to think through very carefully what they're investing in before they make that commitment, because it is multi-year on average. And when you think about this from a time perspective, the amount of time that's associated with analysis of a single deal. I'd say it really depends on how detail-oriented you are, but I would estimate that it can range from as few as four to five hours

Starting point is 00:39:38 to as high as dozens of hours. And that's to get to the point of making the investment decision. With this strategy, taking the time to educate yourself on how to look at commercial real estate deals can pay huge rewards in helping you identify that home run deal. And I would say that in addition, context is powerful. So repetition of this process is valuable. Once you found like you feel like you found a winner, you still must then spend at least a few more hours reviewing legal docs, including the private placement memorandum and the operating agreement.

Starting point is 00:40:09 And so I think when you add it all up, you can kind of see how this form of investing can be extremely time consuming, but also hugely rewarding if you choose the right deals. So from there, let's go on to talk about the second strategy. And that is where we see investors taking an indexed base approach to commercial real estate. In equity investing, we've all seen this phenomenon happening for years. You now see a lot of investors no longer picking and choosing individual stocks. They're more or less assembling ETFs through a multi-fold strategy. I also think about the 10-year bet between Warren Buffett and Charlie Munger as an example of this. This illustrates the power of a passive investing strategy.

Starting point is 00:40:47 There are equivalent approaches in commercial real estate where you can find index-based products that are essentially either a low-load fund or a reet or so-finding. forth, but you can find this type of passive approach. What I would say about this second strategy is that we find it particularly good for investors that are new to commercial real estate investing because it does in many ways shield them from that single asset risk that I talked about a minute ago. And then from there, we would move on to the third strategy, and that is to outsource all of that in-depth analysis of the direct investing route to an advisor. Advisory expertise in commercial real estate, it can be difficult to find. And I would also say that it's generally best suited to

Starting point is 00:41:29 individuals who are either highly time constrained or others who maybe have a higher net worth with really more individualized needs when it comes to constructing a portfolio. And so therefore, they're going to acknowledge that they're not best suited to do that in-depth analysis, but to work with somebody who will directly advise them to do it. When you roll it all up at Crowd Street, I would say that we have found that we have investors across all of these strategies. It's common for us to find investors exiting the single family rental investment strategy and then choosing to adopt one of the other three that I talked about. And I think really at the end of the day, it all begins with the objectives of the investor and then pursuing the strategy that makes

Starting point is 00:42:08 the most sense for that individual from there. All right. Ian, thank you so much for coming back on the show. We always love talking to you about real estate and getting your thoughts on different investment ideas. So if anyone wants to learn more about you, where can they find out about you, more. Binding me, I would say, is pretty easy. I am the only Ian Formigli on LinkedIn, so a simple search there will definitely land on my profile. Also, investors can find me on our website. The Crowdstreet website is www.com. I love getting to know investors. And as you can tell, I love talking commercial real estate. So feel free to hit me up. Fantastic. And we'll also make sure to link to episode 221, where we talked with Ian Formigli the first time about building the business.

Starting point is 00:42:54 basis around understanding commercial real estate. Ian, it was a pleasure to have you on here on the ambassador's podcast. Thank you for our time. And I think I speak for everyone when I say that we always learn a lot from you and we hope we can invite you back on another time. Absolutely. Thank you. Preston's day. It was an honor to come back and I look forward to the next conversation. All right, guys. That was all that Preston and I had for this week's episode of the Amherstas podcast. We see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription

Starting point is 00:43:32 to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP239: Commercial Real Estate Investing w/ Ian Formigle

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