The Sleeping scale of Real Estate Investments

In the 1970’s Professor Burton G. Malkiel published “A Random Walk Down Wall Street” which promulgated his sleeping scale of investments (i.e. Stock, bonds, mutual funds, etc.) and correlated the amount of sleep one could get or lose based on their choices of investments. I have borrowed, “somewhat liberally” from his book and therefore give him full credit.

A relatively new arrival on the scene is the DST (Formerly TIC’s) or Delaware Statutory Trust. Briefly, these are “syndications” that are put together to take advantage of the 1031 Tax Deferred exchange. One benefit of DST’s is they allow the buyer to purchase an asset that may have traditionally been out of reach for an individual investor. Most assets are managed by a “Sponsor” which usually has a good deal of their own money at risk as well as that of the investors. The downside is that there is no defined market for those who want to exit a DST so liquidity is an issue. Another issue is that there are two warring factions in the DST industry, the Real Estate variety which sells as a true deeded interest and a Security version that is sold as shares. Both are real estate based but the fees and loads can vary greatly.

Next on our scale is the single tenant office/industrial property with regional or local credit. Unlike the large national companies the Tenant is not a national player and is therefore presumed to be of a lesser creditworthiness. This does not necessarily mean that they are less valuable as a tenant, it is simply an indicator of resources in the event of a default. There is no corporate headquarters to appeal too, and generally no prominent board of directors to embarrass publicly. The risk is what you see, is exactly what you get. Given the increase in risk associated with a regional or local Tenant you will see an increase in the yield required to entice investors.

The only reason I put medical office buildings lower on my scale is due to the nature of that business (especially since Obama Care, and Trumps threatened repeal). Unlike warehouses most medical space requires a huge, and I do mean HUGE amount of build out. I have seen dental offices cost over $250/sq. ft. and that excludes wallpaper, paint, and all the other niceties. The good news is once you get ’em in, you can’t hardly get ’em out. Doctors and Dentist are loathe to move, unless it is absolutely necessary. The downside is that the space is highly specialized, doctors can be difficult tenants and can be demanding. Fully equipped and built out medical/dental space can be difficult to re-lease and the time on market can be exhausting.

In my opinion Retail Centers are like college football, a whole lot of action and excitement and at any given time there can be a major upset. Retail centers are tied to retail sales, and retail sales are tied to disposable income and consumer attitude. If someone with authority like Janet Yellen (Ben Bernanke was in the early version) whispers the “R” word, consumer attitudes change overnight, bond traders throw themselves out their office windows and retail sales are off for the next quarter. Neighborhood and community centers are more susceptible than regional or super-regional malls because they are dealing with “man or woman on the street” kind of Tenants and generally not the big national Tenants. The challenge is the volatile nature of the retail business in general, think in terms of sit-down restaurants or hair and nail salons. How many seem to come and go on a weekly basis?

Dead last on my list Multi-Family!! Unless you’ve been in a coma for the last three years you are probable aware that there is something of an oversupply of condominiums in the Tri-County market (Again and only 10 years later). Here is my prediction; they are not going to sell quickly! In fact, I’ll even go out on a limb and state, for the record that many will be put back on the market as rental units! You see, people bought these units’ “pre-construction” and knew, absolutely, positively, beyond a reasonable shadow of a doubt they could sell them for a much higher price later. Surprise, markets don’t always expand, prices don’t always rise, and there is not always a “greater fool” waiting to bail out a poor investment. As those units come back on the market they will compete with stock in the marketplace, thus driving down prices and driving up concessions. The only expansion in the Multi-Family market I see in the foreseeable future is in affordable units. The challenge there is finding land at a price point that will allow affordable housing developers an opportunity to make a profit.

In conclusion, I think it’s time to get back to reality, transactions must cash flow, you can’t convert everything to condo’s, and there is not always someone out there who is willing to buy your mistakes at a premium.

Invest in real estate, real estate with positive cash flows, long-term tenants, with the appropriate amount of leverage with a specific goal in mind. Always remember that the one constant in commercial investment real estate is that the market changes…it always does!