Investing in the FutureCommercial Real Estate Investment in Nevada

 

There are five types of commercial real estate investment properties: office, industrial, retail, multifamily, and the niche market of hotel or hospitality properties. There are a handful of other products, but those are the most common for investors to take interest in.

There are also different types of commercial real estate (CRE) investors. “You have investors that are buying commercial real estate with the intent of preserving their wealth; they want to get a return on their capital, a return on their money that’s better than if they invest with a savings account or stocks, bonds or treasuries,” said Todd Manning, managing broker, NAI Excel.

Some investors are looking for tax advantages of owning CRE. Others just want to diversify their money, putting some into stocks, some into real estate, some into businesses. Business owners may choose to buy property as an investment, or to run their business out of it in order to control costs and find tax savings; for others it’s a place to park money, said Manning.

“Real estate, if we just look at the basics, is a longer term investment. It’s a liquid investment,” said James Griffis, SIOR, principal, Avison Young. “It’s a great way to compound your money over a longer period of time.” Unlike with stocks, there’s no concern the company being invested in will go out of business. It’s about the property, and the location.

Investors can work with managers, or purchase assets on their own and run the process and decision making. “It really depends on what the investor’s preference and experience is, which will determine which avenue they choose,” said Brendan Keating, principal, Logic Commercial Real Estate. Investors can choose to work with a broker. “We run closed end funds which investors invest into, and we make the decisions of what assets to purchase, how to stabilize the assets, how to finance and when to sell.”

Investors can invest as individuals or as groups, working with the broker, advisor, real estate manager, group members pooling their wealth to purchase property. They can diversify into multiple properties. Or investors can work with an investment trust. “That’s a little more liquid because you’re just buying shares of a company or of a real estate portfolio,” said Griffis. “So it’s easier to get into and if you haven’t had exposure to real estate, it’s a little less scary, because you can get your money out whenever you need it.”

In the U.S., CRE transaction volume in 2024 is a cumulative $40.1 billion transacted across major property types in Q2, down 9.4 percent compared to A2 2023, though up 13.9 percent versus Q1 2024, according to Altus Group (U.S. Commercial Real Estate Transaction Analysis – Q2 2024).

Things are moving.

Best in Class

The darling of investment real estate over the last four or five years has been industrial. Demand for industrial properties has grown as technology companies have grown and needed space, and logistics and distribution warehouses meet the demands of online shopping that boomed during the pandemic and continue to grow.

“There’s stability in the market and we can find some value in the market on the industrial properties,” said Griffis. Some questions investors need to ask at that point—”What are we buying this at? Can we buy that and what would it cost us below cost of the building? Is appreciation going up on the investment? What does occupancy look like so do we have a steady cashflow right now or are we looking to replace a tenant?”

The last questions are what are the lease rates currently being asked of the property? Are they below market rents? “First thing an investor wants to do is move his lease rates up as soon as he can, as soon as that lease runs out, and then what does that environment look like? Are we at or higher than what the market is?” said Griffis. “So if we can buy a property [with a] low lease rate, we can move that up in a short amount of time and we don’t have to wait too long, typically 12 to 24 months. Those are all things where it would be a good investment opportunity for your investor.”

The most popular class of product in a given market can vary depending on that market. Retail is generally the largest category. “It’s the most inventory of properties and can break down a lot smaller buildings and tend to transact more often than any other product type,” said Manning.

The most common properties to invest in are often what’s currently the hottest asset class. That’s what attracts the most capital. “I read an article that June 2021 had the highest level of multifamily trades in a 15 year period. You can guess that we were not buying existing multifamily in June 2021 as we couldn’t find the risk/reward returns we search for.”

“Multifamily had a real good run for the last, call it 24 to 36 months,” said Griffis. “They just really ran out with how depressed cap rates were getting. At an all-time high it really needed a reset, which is what we’ve been going through for the last 12 months in the multifamily section. That’s a tough class to be in right now, even though everybody loves it.”

Everybody loves it enough that developers are still looking for land and if they can find the right land and the right price, it’ll sell quickly, said Griffis, but developers buying dirt are paying record prices right now.

Multifamily is actually a residential real estate product, said Manning, but once the property is above four or five units, it’s often viewed as a commercial investment. “A lot of investors get started in multifamily. They may be more comfortable with it and own a few different multifamily properties, especially on the small end. Those can be very hands on projects and very labor intensive, and eventually they may move into a more core commercial product that is a little less labor intensive, and get a property manager to take care of those day to day details.”

Third party property management companies generally aren’t brought onboard for smaller properties because they’re not cost effective. That means the owner deals with the details. But for larger properties when investors are looking for a passive investment, investors may bring on a property manager to handle details like communications between tenants and vendors and maintenance crews and utilities.

“A lot of investors will build property management into their investment analysis when looking to buy a property: I’m going to get a 7 percent return on my investment, and that includes spending X dollars toward property management and all the expenses to operate the property,” said Manning. “And then maybe they’re going to leverage an even higher return with financing, with tax savings, and paying down debt.”

Lending Environment

Lending for investment properties has been challenging for the last several years, in part because the market is coming out of a stretch of time where money was cheap, lending rates were low.

“Now we’re back to where we were 20 year ago,” said Manning. It’s still not a bad time. Lenders are lending. But there’s the consideration of terms and rates. “That’s where the market is weaker. But it’s not shut down. People are still buying deals and people are still getting loans. It’s still chugging along. It’s just not as good as it was two or three years ago.”

In general, the lending environment can be influenced by multiple factors, from regulatory issues to economic stability. Or instability. Political and legislative policy and uncertainty can affect it. “Given that we’re in an election year, it’s even more so,” said Mark Lemon, SVP, CRE relationship manager, Nevada State Bank.

Residual impact of COVID-19 continues to play a factor, interest rates impacting direct borrowing cost, collateral types and supply and demand for each collateral type, credit strength and the type of investor/lending relationships all have an impact.

“Generally speaking, it’s my opinion that the lending environment for banks is improving overall,” said Lemon. “Lending is constrained by interest rates, which impact borrower costs.” Though the Federal Reserve has signaled interest rate adjustments coming in the near future, which should improve lending conditions for both commercial and individual borrowers.

Editor’s Note: As of press time, the Federal Reserve had lowered interest rates by half a point.

“I believe the second half of the year and next year should provide a more favorable overall environment,” said Lemon. “That assumes we don’t get a curve ball from other macroeconomic forces. We remain in an election year, so the uncertainty of that will cause pause for some borrowers. I believe the easing of rates and the ancillary impact that should come from that should improve the cost of borrowing and will improve the near term overall lending environment for borrowers and individuals.”

The lending environment is more difficult in 2024 than in 2021-22 for a variety of factors. “Rising rates causing uncertainty in future pricing of CRE, many loans are priced with a spread above the 10 year treasury,” said Keating. “The 10 year was 0.50 percent in July 2020 and is currently 3.86 percent (a 672 percent increase).”

Other factors include lenders not knowing what, if any, losses they could incur now, so they’re choosing to reserve capital and be cautious until they have a clearer picture of where rates stabilize.

And then there’s the fact that in 2023 there was $5.2 trillion of CRE debt in the U.S., half of which are set to expire before 2027. “All these loans will need to be refinanced, paid off or assets have to sell,” said Keating. It’s an uncertain market.

“Valuations of investment properties have a direct impact of interest rates on cap rates. It also impacts the lender’s ability to underwrite and lend on particular investment assets,” said Lemon. “Some recent headwinds for property owners include increased operating expenses, higher insurance costs which play a large factor in higher operating costs. There’s plateauing and sometimes declining rental rates, as supply outweighs demand in some sectors. Office properties in particular continue to be impacted by a remote work trend, driving lower demand for office and creating headwinds there.”

Large office towers or campuses, or big retail centers or distribution facilities are often owned by very large institutional companies. “Those are the two different groups of investors as I see it,” said Manning. “There’s more nuances than that, but in simple terms, it’s private versus public investors.”

Public doesn’t necessarily mean public, just that they’re large companies and sometimes there can be public funds involved, investment trusts, or the public can invest in the properties. Other times it simply refers to massive companies.

For CRE investors specifically, banks continue to fund loans to well-established borrowers. That’s still constrained by a high interest rate environment and typically requires a 10-year lending relationship with more upfront equity.

Best for Investments

So given market conditions, what’s the best class of property for investment? Any property that has strong demand. Location matters, but a great submarket with great demographics and fundamentals can still have a property that’s underperforming, due to curb appeal, layout, age. Perfectly good buildings can stop being perfectly good if people and businesses are moving out of the area, shifting the property from higher caliber, better capitalized tenants to smaller businesses or startups, and can see vacancies increase.

“A property that was historically fully occupied or 95 percent occupied, if the market vacancy rate is 5 or 7 or 8 percent and your property is operating at 92, 93 percent occupancy, for all intents and purposes it’s fully occupied,” said Manning. “But over the life you might see that start dipping down to 85 percent, 80, 75 percent, and if you have a market vacancy that’s 7 or 8 percent and you have a property sitting at 75 percent occupancy, you may have a functional problem with that building. It may be a market shift, and you may be able to repurpose it, rehab it, rezone it, and in some cases those buildings are just demolished and the use of the property itself is what’s repurposed.

“By pure investment dollars, institutional investors make up the majority of the CRE investments,” said Keating. “But there’s room for everyone in the market.” There’s room for large asset managers, midsized asset managers, and private ultra high net worth investors. “That percentage of the market also changes as institutional capital pursues different asset classes or decides not to allocate anymore to an asset class. But they carry the biggest influence on when asset classes are in favor or out of favor by the pure amount of capital they manage and can invest into an asset class.”