We Study Billionaires - The Investor’s Podcast Network - TIP263: Commercial Real Estate Investing - w/ Ian Formigle (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we have the pleasure of talking with a former guest who's a commercial real estate investment expert Ian Formigli. Ian's company, Crowdstreet, has conducted over 300 offerings and has allocated over $10 billion of deals. Ian has 20 years of experience in commercial real estate, and he's a graduate of Berkeley, and he's also the author of the Comprehensive Guide of Commercial Real Estate Investing. So without further delay, here's our chat with Ian Formigley.

Starting point is 00:00:28 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. Hey, everyone, welcome to The Investors podcast. I'm your host, Preston Pish, and as always I'm accompanied by my co-host, Stig Broterson, and we've brought back a popular guest to talk about commercial real estate, Mr. Ian Formigli. Ian, welcome back to the show. Preston Stig, it's an honor to be back. great time on our last two episodes and I'm looking forward to the show today. So, Ian, before we talk more in detail about how to include commercial real estate in our portfolios, which is the framework for our discussion here today, could you give us a high

Starting point is 00:01:21 level perspective of commercial real estate for our audience that is typically heavily invested in stocks but might consider diversifying into commercial real estate. Yeah, sure, I'd be happy to. I think to begin with, if for investors who are new to commercial real estate investing, I think one of the main things to understand, it is the world's largest alternative asset class. The types of underlying assets in commercial real estate, they include things like multifamily, office, industrial, retail, and hotels. It can even include self-storage, senior housing, mobile home parks.

Starting point is 00:01:55 Commercial real estate investors are typically looking to earn returns through a combination of annual income and appreciation that's realized at sale. everywhere you go, you're going to encounter commercial real estate, and a lot of it is privately owned. And I would say that similar to stocks, you can pursue different strategies within commercial real estate. Some strategies are going to focus on total return, while others are going to focus on current income. I think the part and the beauty of commercial real estate is that it can be structured in myriad ways, and those ways can be tailored to suit the goals of the investor. So when we think about it holistically, commercial real estate complements a well-diversified

Starting point is 00:02:33 portfolio because it's proven over time to produce attractive returns that are not perfectly correlated with the overall market. This means that it can enhance overall returns in a portfolio while also reducing volatility. And that is why you will regularly see it utilized by sophisticated investors such as pensions and endowments. So, Ian, let's be more specific. We've previously talked about the sharp ratio here on our show. And in short, the sharp ratio is a measurement of the expected return compared to the volatility of your portfolio. Could you provide some numbers based on how the sharp ratio changes for a 100% stock investor if they would start to include commercial real estate in their portfolio? This is an interesting question because we actually ran a similar

Starting point is 00:03:18 type of analysis late last year in tandem with a registered investment advisor here in Portland, Oregon. We began with actually not taking 100% stock portfolio, but a 6040 stock bond portfolio. and we analyzed the expected return, the standard deviation, and the sharp ratio for that portfolio over the next 10 years. Because this particular RIA has a reasonably conservative outlook when they think about the next 10 years, the return estimate for that 6040 portfolio was 5.49%. It had a standard deviation of 9.19%. And that resulted in a sharp ratio of 0.39. So then we began with that portfolio, and then we created a second portfolio where we reduced the equity component to 50%, and we substituted a 10% allocation of private equity real estate.

Starting point is 00:04:08 So to determine the expected return on that 10% component, we used the 10-year targeted average returns for the entire Crowd Street marketplace up until that point, which is about a 14% IRA annualized rate of return over that 10-year period. So this is a hypothetical scenario, but that's the data that we had to work with at that point. When we added the 10% private equity component to the portfolio, the returns went up. They went up from 5.49% to 6.28%. The standard deviation did definitely go up. It went up from 9.19% to 9.76%, but it didn't go up proportionally, and that's due to the non-correlated aspect of the real estate component. In the final analysis, the sharp ratio increased in this case from 0.39 to 0.46, and that was by infusing

Starting point is 00:04:55 that 10% allocation of private equity. And so to sum it up, I think this is part of the reason why I believe that adding a commercial real estate equity component to a diversified portfolio increases the overall portfolio returns for each level of risk taken. Is there such a thing as an optimal commercial real estate percentage in your portfolio? And here in this example, for instance, you mentioned 10%. But could you provide some of your thoughts in terms of how should we think about including it in terms of a quote-unquote optimal allocation of commercial real estate in a stock portfolio? You know, real estate as a component within a portfolio will range. And we will see that range in a portfolio from high single-digit percentages, 7 or 8%,

Starting point is 00:05:40 all the way up to 30 or 40%. The right level of allocation is really going to boil down to who is the investor. So I'll kind of walk through a couple examples. That high single-digit percentage, that's sometimes a real. reasonably conservative allocation from a pension, for example. When we think about endowment investors, they're going to range typically between 10 and then maybe 20%, maybe as high as 25% when they over-allocate, they're going to come to their own conclusions on where they think they fit within that cycle, and they're going to look to span commercial real estate as a percentage of the portfolio

Starting point is 00:06:14 where they deem they are in the cycle. And then in that scenario where we are seeing 30% or more, that's typically very high net worth, ultra high net worth investors, or in this case probably family offices, because they have a strong cash position and they have the luxury of investing over a long period of time, that's where they're going to seek to infuse real estate as a long-term store of wealth in their portfolio. So I guess to sum it up, anywhere from six or seven percent all the way up to 40 percent, and it really just depends about what type of investor are you and what are your objectives. Another thing I would like to introduce here to the listener is liquidity premium.

Starting point is 00:06:54 And have a discussion about that because generally you can say that investors prefer to have liquid investments. Now, it gives us more flexibility to put money into the best investment with a very short notice. So for instance, everything else equal. Investors would prefer tradable securities instead of equity in their home because the latter is liquid. They would need to go to the bank to get a new loan and Pinterest and that or sell the house, which is even worse, I guess.

Starting point is 00:07:19 I've heard you ask you for liquidity premium can also be an advantage for you if you're a long-term investor. Why is that? I will oftentimes speak with investors about the concept of saying the real estate component is not the component

Starting point is 00:07:33 to seek for liquidity in your portfolio. You do need to think about it more holistically in this case. And then if you can give up the liquidity, then you have the benefits of earning the return. So let's dig into that a little bit. So liquidity premium from the get-go is really associated with commercial real estate investments, and its concept is rooted in the fact

Starting point is 00:07:54 that because you are ceding the ability to liquidate your investments with the click of a button, you must be compensated in the form of greater returns. Or to put it another way, if you're not getting compensated, then why give up the option of liquidity? When we see this, I mean, we can even look and see this effect in the equity markets. When equities go from private to public through an IPO, oftentimes the IPO process results in a jump in valuation for that company. In fact, there's an NYU Stern School of Business Study that estimates that the average valuation premium for a private company going public is about 20 to 30%.

Starting point is 00:08:31 And another way to quantify this is to compare commercial real estate returns to S&P returns. If we begin with the long run average return of the S&P is about 10%. When I think about equating that level of risk and return to the S&P return, but from a commercial real estate perspective, I tend to land on the profile of a core plus real estate investment that's located in a great market, and that is leveraged at about 55 to 60%. So with that risk profile,

Starting point is 00:08:59 you will typically target a net annualized rate of return of approximately 12 to 13 percent, and that will assume a holding period of roughly 5 to 8 years. That means that provided that you are able to commit to a 5 to 8 year period, potentially of illiquidity. And when I say potentially, I mean a shorter period

Starting point is 00:09:20 most likely in a strong market and a longer period in a weak market, you stand to earn an additional two to 300 basis points per year on that capital relative to what you would normally expect to return in the S&P over that same time frame. But I would say that, again, the key is

Starting point is 00:09:36 that you are committing to hold for multiple years. Consistent returns in commercial real estate, they take the cyclical nature of the real estate market into calculation. We don't know when a market will turn. And if it does, as an investor, you must be prepared to be patient and sell when the market regains strength. And if you're prepared to do that, then you will greatly smooth the volatility of expected returns in real estate.

Starting point is 00:10:02 Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using. Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building

Starting point is 00:10:45 technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience powerful mainstage talks, hands-on workshops on freedom tech and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June. If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedom Forum.com with patron passes offering

Starting point is 00:11:31 deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference, it's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful in the real world? Because the upside is huge, but guessing your way into it is a risky move. With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI Cloud ERP, trusted by over 43,000 businesses.

Starting point is 00:12:04 It pulls your financials, inventory, commerce, HR and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the NetSuite AI connector, you can use the AI of your choice to connect directly to your real business data. This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even hundreds of millions, Netsuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide

Starting point is 00:12:43 demystifying AI at Netsuite.com slash study. The guide is free to you at Netsuite.com slash study. NetSuite.com slash study. When I started my own side business, it suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overweller. and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world,

Starting point is 00:13:18 and 10% of all e-commerce in the U.S., from brands just getting started to household names. It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support. Start your business today with the industry's best business partner, Shopify, and start hearing... Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com.com slash...

Starting point is 00:14:04 WSB. That's Shopify.com slash WSB. All right. Back to the show. So, Ian, let me play devil's advocate here for a second. When I'm thinking about commercial real estate, I'm also thinking about the risk of the commercial real estate owner. On our previous interviews with you, you talked about how commercial real estate on an unlevered basis historically has achieved about a 9% return and up to about 16% with leverage. So if you could elaborate on the different risk factors using leverage and how we should manage leverage to maximize return and minimize the risk.

Starting point is 00:14:44 Sure. And I would say to begin with, you are absolutely correct that you never want to be forced into selling an asset into a weak market. That is a recipe for disaster. When we think about cycles year and year out and we look at the course of history, we would definitely say that if there is a weakness in commercial real estate, it is, the possibility of being exposed to that exact scenario. That is something that we have control over. So let's talk about how to think about it and how to potentially ensure yourself against the possibility of being caught in that situation. Applying correct amount of leverage on commercial real estate is critical, right? It helps to ensure that assets are going to make it through those downturns relatively unscathed.

Starting point is 00:15:25 So when we look at leverage going into a deal, we can use three metrics. and those metrics are one, loan to cost, two, debt yield, and three, the debt service coverage ratio. So let's begin with that first metric, loan to cost. This is the ratio of the total amount of debt used to the cost of the asset, factoring in closing costs and reserves. For example, the average loan to cost across all 360 plus offerings on the Crowd Street Marketplace to date is roughly 67%. 50% or below is typically considered low leverage, and anything above 80% is typically considered high leverage. And I would caveat that these ratios are not absolutes, and they must be weighed on a case-by-case basis. The second metric is debt yield, and that is calculated by taking

Starting point is 00:16:14 the net operating income of the property and dividing it by the loan amount. It's almost a proxy for determining at what cap rate a lender would be willing to own the property. It's basically the cap rate for the lender's level of exposure in a deal. Debt yields are more commonly used in office, retail, and industrial, and less so for multifamily. The third metric really pertains to multifamily, and that is the debt service coverage ratio. This ratio is calculated by taking the annual net operating income of an asset, which, as

Starting point is 00:16:45 we've discussed before, is essentially all revenues, less all expenses, and then dividing it by the amount of the annual loan payments owed to the lender. This metric can be particularly useful because it will tell you how much cushion you have in your net operating income before you can no longer service your debt. And like debt yields, debt service coverage ratios, they vary and they're going to depend upon the amount of debt you use, but in this case, they also change with interest rates. So when we think about these metrics, I think the most interesting and illustrative aspect for investors to grasp is that the lending industry seeks debt yields and debt service

Starting point is 00:17:24 coverage ratios to fall into certain ranges depending upon the asset class. These are two key metrics for how lenders analyze loans and determine loan proceeds. Debt yields, they can range, and they're going to depend upon the asset type and the quality, but in general, you could say that a debt yield of 7% is relatively low, 8 to 9% is good, and 10% or above is considered strong. Let's turn to multifamily assets. Fannie Mae and Freddie Mac are two of the largest lenders in the space. And when they think about sizing up their loans, they're often going to size to a 1.25 debt service

Starting point is 00:18:03 coverage ratio. Debt service coverage ratios from multifamily in general, they can range from 1.1 to maybe 1.6, given relatively normal levels of leverage, say high 60% to mid-70% loan to cost. They rarely exceed 2.0. And if you find them that high, it's usually going to be able to be a lot of cost. it's usually going to require low leverage to get there. All three of these metrics require some learning on behalf of investors. I would say a little bit more so with debt yields and debt service coverage ratios,

Starting point is 00:18:32 but they really are helpful for understanding the risk of leverage in commercial real estate assets, understanding how banks and other lenders look at them and look at risk of lending into a commercial real estate deal. And if you can understand them a little bit like a bank does, you're ahead of the game. Thank you for your response to that. Let me go back to the first ratio there we talked about. Just an example. I think that a lot of listeners, for instance, with their own home, they used to be thinking, well, you know, it's leveraged 60% or 70% or 80%. And you talked about how less than 50% that would be considered conservative and more than 80% would probably be somewhat highly leveraged. Is there such a thing as whenever you mentioned, evaluate on a case-by-case basis, is there such a thing as you are are willing now to take on more leverage,

Starting point is 00:19:21 because that number, that's 60% that you might turn up to like 80% or even more, it's just not as severe for this type of property. When we look at scenarios where we want to contemplate levering a deal more highly, it's really going to depend upon the following things. One, where is the net operating income today? And two, where do we think the net operating income will go tomorrow?

Starting point is 00:19:45 The key difference about a commercial real estate asset than a single family home is that, well, you're paying the mortgage on your single family home with your income. If you feel confident in your ability to service your own mortgage and you see your own income going up over time, that's the scenario where you might feel comfortable sticking your neck out a little bit and levering a home 80 to 90%. If you thought your income was going to go down, well, you're going to put a pretty conservative amount of leverage on that property because you need your mortgage payment to fit within your budget. That same concept applies to commercial real estate.

Starting point is 00:20:20 This would be a good example of where we see adding leverage in a deal, but doing it in a way that makes sense. And that is what we call future funding. In some instances, you put an initial amount of leverage on a property. Maybe that is 65% of the purchase price. But then you believe that you can improve the property. Maybe you're going to buy an apartment complex and you're going to rehabilitate units and improve rents.

Starting point is 00:20:42 If you can do that, then you're going to increase your net operating. income. And in that scenario, oftentimes you can find lenders who will lend you additional proceeds to help you do that work. The reason that the lender is going to do that is because it sees the opportunity for you not only to improve the quality of the asset, but to improve its net operating income. And as we just discussed a minute ago, it's analyzing debt yields and debt service coverage ratios. And if you improve your NOI, well, then all things being equal, your debt service coverage ratio in that scenario is going to go up and your debt yield is going to go up. So the bank is feeling like it is decreasing its risk in that deal. So that's an important way to think about

Starting point is 00:21:26 leverage in a deal is to really understand the NOI and understand how the NOI will change potentially over time. Thank you for response. Thank you for making it very relatable. I guess that most people whenever they do hear about commercial real estate, they automatically think about their own home and how they manage that. To make it again more later, especially for our listeners, I would like to draw a parallel to stock investing. Because we as stock investors look at different indicators for the entire stock market. One of the indicators that we often talk about here on the show,

Starting point is 00:22:01 that's the Sheila PE. So we are looking at what is the stock market valuation for the US, or what's the stock market valuation for Germany or whatever kind of market that is? because it gives us a more high-level perspective that now might be the time to start looking specifically at stocks in that country. Of course, you can always be lucky to catch a fish. But if you know what's pond,

Starting point is 00:22:22 is the right one to start fishing, you increase your odds. That's also higher I'd like to draw this parallel to commercial real estate. We previously here on the show talked about a few of the metrics that you can use for the individual asset. For instance, the cap rate you mentioned before. how do you take the temperature of the entire commercial real estate market?

Starting point is 00:22:41 It's kind of like to give you an indicator that perhaps this is the pond that I should start fishing in. Yeah, and it can be a little bit challenging to understand where the commercial real estate market is today and where it's going. That's because a lot of that market is private. And for individual investors, it's important to note that the most relevant data sources are provided by third party groups. and they gather data through what I would describe as grassroots collection efforts.

Starting point is 00:23:09 Within the industry, we watch transaction volume and price per square foot data on a national basis, and this kind of data is provided by companies such as CoStar and Real Capital Analytics. Unfortunately, for the individual investor, this data is proprietary and it is expensive to obtain. But for people that don't have access to the same types of industry data as market professionals do, there are a few alternatives, so I'm happy to walk through them. The first is the Neary Index. And Ney-Reed stands for the National Association of Real Estate Investment Trust. This is an index that tracks the performance of 221 publicly traded reeds, 185 of those of which trade on the New York Stock Exchange. And so that index currently has a total market cap of about $1.25 trillion, which is a

Starting point is 00:23:57 pretty good amount of total assets within the market. So that's not a bad place to start. The second I would say is the NACRIF Property Index or the NPI. NACRIF stands for the National Council of Real Estate Investment fiduciaries. This is a group that has been tracking a nationwide property index dating back to 1977. It looks at the returns for commercial real estate properties held for investment purposes only. And it analyzes them on an unleveraged basis. The NPI is a lagging indicator. It's published every quarter, and it's going to look back on that previous quarter, but it is

Starting point is 00:24:35 helpful to view. It could give you a sense of where the market has been and where it might be going. The third, I would say, is the Dow Jones U.S. real estate index. Now, we have an index where investors can track public real estate equities on a daily basis if they choose. It does have some highly relevant industry stocks in it, such as Avalon Bay, Prologis, Simon Property Group and Equity Residential. I would say that there's also some noise as well in that index.

Starting point is 00:25:03 For example, Crown Castle is one of the stocks, and that's a cell tower company, which honestly doesn't really correlate to what we see in the private equity real estate market. Finally, what I would say is that when we think about all of these different indexes, is that one common thread that you're going to find across them, is that they tend to move more slowly

Starting point is 00:25:20 than something like the S&P, and that is a reflection of the industry as a whole. Commercial real estate is comprised of a lot of private decision makers, assets are trading on a monthly basis, quarterly basis, yearly basis. They're not trading within microseconds. If you think about any index that you can think about for publicly traded securities, slow that down in time. And then you're going to start to understand that commercial real estate does move. But relatively speaking, it moves at a glacial pace. So, Ian, what are the major macro trends that you see for commercial real estate in the next

Starting point is 00:25:50 five to 10 years. We see a number of trends across product types, geography, environment, just to name a few. And I'm going to touch on two of them, because I think they're pretty relevant to our environment today. And they're both anchored in the concept of affordability. So first, we see a growing housing affordability crisis in the U.S. that only looks to intensify over the next five to 10 years. Right now, about half of all U.S. renters, or roughly 21 million and households spend 30% or more of their income on housing. So we are seeing opportunities to refresh aging 1970s and 80s vintage multifamily housing across the United States.

Starting point is 00:26:33 And we don't see this opportunity abating anytime soon. And as evidence of this trend, I often look to Starwood Capital Group as a company that sees trends and mobilizes on them pretty well. For example, they were one of the first institutions to acquire large amounts of single family residential real estate coming out of the Great Recession. So when you look at what Starwood is doing today, they're acquiring affordable housing. They've actually acquired 20,000 affordable units across Texas and Florida just in the last couple of years. And as for demographics, Harvard's Joint Center for Housing Studies is projecting that a formation of roughly one million new households per year

Starting point is 00:27:14 through 2035. And if we combine that new household formation data with an environment where three out for new jobs in the U.S. are relatively low paying, you can see why the U.S. is going to continue to produce more renters than homeowners over the next decade, and those renters are going to need affordable housing. Second, moving on with this idea of affordability, we see that moving into another trend as well, which we call the middle market for senior housing. Similar to the multifamily market, we've seen a strong market for senior housing, but I would say that unfortunately, developers have been oversupplying the high-eastern. end of this market, and that has led to an overall occupancy level of 88% nationwide, and that marks

Starting point is 00:27:57 a seven-year low. And so, according to a study done by the National Investment Center, the next big trend in senior living is specifically in this middle income senior housing market. This middle market is anticipated to grow by more than six million people within the next decade, and that's going to translate into more than 700,000 senior housing units that will be needed to serve this middle income bracket. Right now, the majority of middle income seniors are not going to be able to afford assisted living that cost $60,000 or more per year. However, if we reduce that annual cost to $50,000, you pick up an additional 2.3 million seniors who can now afford assisted living. If the price drops further to $45,000 per year, you add yet another 3.6 million seniors,

Starting point is 00:28:51 and that would bring the total estimated market size to 10.2 million people. So when we look at the middle income demand and supply gap out there right now, we see that as an underserved market and a market opportunity. I would expect that the industry over the next 10 years is going to adapt to serve it. And in addition, as it adapts to serve it, we would expect to see that a lot of the industry, lot of these units are going to be delivered in 18-hour cities, and that is an alternative to the price-year 24-hour cities. And we're going to need to see some of that because, as I talked about, we really need to think about affordability. We have to find a way to get senior housing,

Starting point is 00:29:29 assisted living, down to $45,000 per year. Perhaps not too surprisingly for our listeners, I want to transition back into stock investing and make this parallel between stock investing and commercial real estate. We've talked about insider trading here before on the show and different case studies. And as we all know, it's legal whenever you are involved in stock investing. And that's also why all insider trading, all that activity is disclosed and why insiders are so heavily regulated. When it comes to commercial real estate, it seems like it's played by different rules. It's generally not illegal. And if anything, that's often how and why most deals are made. I'm curious. And with all the

Starting point is 00:30:11 experience that you have in commercial real estate, do you have a good story about how you or Crowd Street have utilized insider information? I do. There's a story in our background. You make a really good point because I would start by saying that insider information in the commercial real estate industry, it's really just referred to as imperfect information and its use as prevalent. I often speak with investors about how commercial real estate is a highly inefficient market and imperfect information is really just one example of those inefficiencies. A story that illustrates the concept of imperfect information in commercial real estate transactions occurred for us towards the end of 2016.

Starting point is 00:30:50 In this case, we had a sponsor that is based in the Bay Area who brought us a 350,000 square foot office building located in San Jose. This sponsor had it under contract to purchase for $36 million. So for starters, $105 per square foot going in basis looked great. But what I would say that what made that deal immediately compelling was the fact that by talking the seller into letting the buyer, in this case the sponsor, start leasing that property while it was under contract. This sponsor had been able to increase occupancy from 55% to 67% just by the time they approached us with the deal. So if we think about that from a net operating income perspective, right, because NOI is the key value driver of the value of commercial real estate. state. In this case, the NOI had increased from $2.1 million to $2.7 million during that contract

Starting point is 00:31:44 period. Now, if we apply the assumed exit cap for this particular deal, which was 7.5%, that translated into an additional $8 million of what we would say is imputed asset value. So in essence, this was a $36 million transaction that was already arguably worth $44 million. before we even closed on it. So we viewed that situation as a form of risk arbitrage because the sponsor had a contract to acquire the property below its current value. It's almost equivalent to a situation in the stock market when you've been given the option to buy call options

Starting point is 00:32:23 far below where they're currently trading in the market. There's definitely still risk, right? There's still risk that we have to acquire the property. We still have to execute the business plan and we ultimately have to exit it, but there's expected value going in. And so in this case, we closed that deal with a sponsor in March of 2017, and within two years, that group was able to refinance the property, return 91% of originally invested equity to the investors, still own the asset, and now, as we enter the fall of 2019, that sponsor is now looking to sell the asset,

Starting point is 00:32:55 and at its current estimated value, investors might be looking at somewhere around double their money inside of three years. again, but we'll find out when it actually occurs. So I would say that periodically, we find opportunities like this where we see immediate value going in, and when we find them, we definitely jump on them. 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.

Starting point is 00:33:27 VANTA automates your compliance process and brings compliance, risk, and customers, 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. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Ryder spend 82% less time on audits with VANTA. That's not just faster compliance, it's more time for growth. If I were running a startup, or scaling a team today, this is exactly the type of platform I'd want in place. Get started at Vanta.com slash billionaires. That's Vanta.com slash billionaires. Ever wanted to explore the world

Starting point is 00:34:16 of online trading, but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&P 500, NASDAQ, Bitcoin, gas, and much more. Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity, you'll be able to trade it in just two clicks once your account

Starting point is 00:34:56 is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited risk-free demo account with charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus.

Starting point is 00:35:25 Billion dollar investors don't typically park their cash in high. yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes thanks to the Fundrise income fund, which has more than $600 million invested and a 7.97% distribution rate. With traditional savings yields falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise Income Fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since inception

Starting point is 00:36:12 is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right, back to the show. So commercial real estate is a huge $15 trillion market that often goes under the radar because when you say real estate investing, most people think single family residents. Could you please outline the different value drivers behind both types of investments? There are multiple common drivers for the underlying value of single-family residences and

Starting point is 00:36:59 commercial real estate, but there's also one key differentiator. And so I'll describe both. Let's begin with the commonalities. First, when we look to both types of real estate, I would say that we see five similar drivers, and those are in the form of one, population growth, two, job growth, three, supply growth, four, replacement cost, and five interest rates. All types of real estate, no matter what they are, are driven by the basic economic concept that when more people demand real estate in a given location, when they have more money to spend on it,

Starting point is 00:37:33 when its supply is constrained, and when the cost to build it is increasing, well, then demand is going to exceed supply and prices are going to increase. And that fifth component, interest rates, well, those are going to fluctuate. and generally speaking, you will see inverse pressure on real estate prices with those fluctuations in interest rates. So while single family and commercial real estate might have similar drivers, there definitely is a key differentiator, and that differentiator gives commercial real estate a business model. And as we've discussed, that business model is the net operating income or NOI.

Starting point is 00:38:11 I actually wrote a Forbes article about this concept. So exclusive to commercial real estate is the fact that much of its value is derived from its NOI, something that we've talked a lot about on the podcast so far. And just to reflect, NOI, again, is what's left over after deducting all operating expenses from a property's total revenue. And because NOI is a major factor in determining the value of a commercial real estate asset, this means that its value can increase or decrease regardless of what is occurring in the underlying market.

Starting point is 00:38:45 And that is simply just not the case for single family residential real estate. And so this is what I mean by saying that commercial real estate has a business model. If you are able to acquire commercial real estate asset and increase its NOI through things maybe such as leasing or increasing rents, then you can earn a return all else equal

Starting point is 00:39:05 regardless of the market. You don't need to hope that that underlying market is moving in your favor. Ian, we would definitely make sure to link to your Forbes article here in the show notes of this episode. We have previously talked about how finding the right investing strategy for you that fits with your personality and why that is so important. Now, for those of our listeners, they're not too familiar with real estate investing. And I don't know if you can make a strict distinction here, but could you talk about which type of investor that might be more suited for single

Starting point is 00:39:38 family residence and which type of investor that would be better suited for commercial real estate? I'd be happy to. And I do think that owning single family rentals as an investment is markedly different than passive investing in commercial real estate. And in this case, I think I can actually offer a balanced perspective because I've done both over a period of multiple years and have had good experiences with each one. To begin, when thinking about single family rentals, there are a couple of key things to keep in mind. First, when you acquire a rental property, you typically place a mortgage on that property that has recourse to you, which means that you personally guarantee its repayment. This aspect of a is important because it means that you are

Starting point is 00:40:20 potentially risking more than 100% of your equity investment in the worst case scenario. And this aspect of a single family rental is just one example of how you take an active role in its operation. Aside from mortgages, there's things like property insurance, capital expenditures to manage, leasing, the list is going to go on. And it is possible to outsource some of the day-to-day issues through third-party management, but the cost of that in the single-family space is relatively high. And I will definitely say that that company will never care about the property like you do. So because of the nature of single-family rentals, I often speak with investors about the idea of viewing them more as operating a small business than making an investment. Because

Starting point is 00:41:08 that's what it's going to feel like a year into it. I used to own and manage a portfolio of single family rentals for years, and I felt that doing it well usually meant being actively involved. And for some investors, that's perfect, because those investors might be looking for a way to turn their own elbow grease into wealth. And if that's the case, it is a great vehicle for doing so. However, I don't really recommend them for an investor that is seeking a passive investment. So now in contrast, let's talk about commercial real estate investing. And where I would begin there is to say that as an investment, I think it fits better into the perspective of diversifying an investment portfolio through exposure to alternative

Starting point is 00:41:50 assets. With passive commercial real estate investing, you can more easily translate your opinion on things like markets and asset types into an investment thesis. Just think about the scenario of, as we saw the rise of Amazon five, seven years ago. If you believed in the rise of Amazon, then you could have made a calculated bet in a market like Seattle. And if you had, you would have been rewarded handsomely. With this approach, you generally, when you're looking at commercial real estate deals, you get to select a professional investment manager, which is the operator or developer. And in some instances, these are companies that have

Starting point is 00:42:26 acquired billions of dollars of commercial real estate in that same market. You evaluate the operator similarly to how you would evaluate a fund manager, and once you find one that you like and the one that you like has a deal that you believe in, well, now you can take a calculated risk. And by repeating this process and diversifying across multiple operators and asset types and geographies, you begin to generate greater returns in your portfolio that have less correlation within the portfolio to stocks and bonds, as we discussed earlier. but you are taking a passive approach. So I think to wrap it up, I'd say that single-family rentals and passive commercial real estate

Starting point is 00:43:09 investing, they're different. And selecting the right one for you, it really just boils down to your objectives. So, Ian, for almost all investors, our end goal is what we typically refer to as passive income. Many stock investors try to achieve this by investing in dividend stocks and rely on the dividends rather than capital gains to provide them with a smooth and perhaps even growing passive income. Is it possible to turn commercial real estate into passive income? There is such a thing. I definitely think it is possible to achieve relatively,

Starting point is 00:43:45 and I would say relatively reasonably targeted passive returns through commercial real estate. So let's walk through it. So, and to begin, in a yield-starved world, you know, I definitely do think that there's ways to structure yield into real estate deals to generate consistent returns. And it's going to especially occur when you combine credit tenants with long-term leases. If you have that scenario, real estate can begin to function much like a corporate bond. I'll provide a recent example from our marketplace.

Starting point is 00:44:12 We recently recapitalized the Nobu restaurant in Washington, D.C., with the company who redeveloped this building along with 59 luxury residential condos that were stacked above it. And so rather than selling the commercial condo space that housed the restaurant, along with the rest of the condos, the development group saw an opportunity to earn a stable long-term yield. In this case, we were able to collaborate with the developer to determine a strike price, where investors are targeted to receive a 14% total annualized rate of return over a five-year hold, but with a 6% initial yield and the possibility to grow that yield up to 10% assuming that the restaurant's sales grow and its percentage rent kicks in. Percentage rent is sometimes structured

Starting point is 00:44:58 into retail leases. And what that is, well, it's essentially additional rent over and above the base rent that is tied to sales. So the keys to this deal were that the term of the Nobu lease is 20 years. The restaurant sits in a prime location in D.C.'s west end. Nobu has a strong balance sheet. And it doesn't hurt that one of the co-founders of Nobu is Robert De Niro. So in this case, receiving a 6% initial yield that might grow to 10%, but we have to see how sales go at the restaurant location, while investing in a core Washington, D.C. location, can offer a great way to earn a consistent, passive yield

Starting point is 00:45:44 through commercial real estate. And hey, you don't mess with property Niro, right? I mean, if that isn't the truth. But, you know, Ian, that's a great example of what you and Crouch Street are doing. Where can the audience learn more about you and Crown Street if they want to see some of these projects themselves? So to begin with, I'm easy to find on LinkedIn as I'm the only Ian for Migli. I always invite investors to ping me there and begin a conversation.

Starting point is 00:46:12 It's fairly obvious that I always love talking real estate. And then otherwise, to learn more about Crowd Street, well, check out our website. It is www.com. There's a lot of information there. There's articles that I've written. There is upcoming events. There's a wealth of information there, and I invite investors to check it out.

Starting point is 00:46:31 Fantastic. And we will, of course, make sure to link to Ian and to link to CrowdStreet together with Ian's article to Forbes that we talked about before. Ian, thank you so much for taking the time out of your business schedule to speak with Preston and Meere here today. Preston and Stig is my pleasure. I love coming onto this podcast.

Starting point is 00:46:49 I love what you guys are doing. Keep up the great work. Well, thank you. Thank you so much for your kind words. All right, guys. That was all the Presta and I had for this week's episode of The Investors Podcast. We see each other again next week. Thank you for listening to TIP.

Starting point is 00:47:05 To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP263: Commercial Real Estate Investing - w/ Ian Formigle (Business Podcast)

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.