What is co-investment in commercial real estate?

co-investment in commercial real estate

Commercial real estate investment is a robust strategy to amass long-term wealth. Passive income stream, portfolio diversification, capital value appreciation- the list of advantages goes on. However, due to a low appetite for risk regarding mega-funds and greater capital requirements for large real estate projects, individual investors are missing out on more viable opportunities in the commercial real estate market. To easily invest in high-quality institutional projects, average investors are preferring Co-investments.

For the longest time, accredited investors and real estate private equity funds have accessed capital-intensive, profitable real estate ventures. However, co-investment in commercial real estate is a lucrative risk-adjusted return alternative.

It is a burgeoning platform that allows non-institutional investors to combine forces and resources and participate in a collaborative ownership arrangement.

Hence, co-investment in commercial real estate provides smaller investors with better deals, better economics, and greater risk diversification.

What is co-investment in commercial real estate?

Co-investment in commercial real estate implies the consolidation of funds that several investors contribute for investing in a specific commercial real estate project or portfolio.

In co-investments, each co-investor owns a percentage of the asset in proportion to their capital contribution and the asset’s overall purchase price.

The co-investors are direct owners of a commercial real estate asset when they invest in it directly with a lead sponsor. A lead sponsor is a primary investor or a fund that sources and structures an investment.

When a lead sponsor lacks sufficient funds to cover a commercial property deal, they open a deal to co-invest for external investors. These co-investors can contribute smaller sums for as little as $30,000 in these properties and secure superior returns.

How does it work?

The co-investors make additional investments alongside the fund in the transaction and enjoy a stable position in that asset or portfolio. Once the fund manager secures adequate funds, the transaction is shared between the primary fund and the co-investors on a pro-rata basis.

To close the transaction the primary fund requires investors to commit the capital immediately. However, they charge fees only on the invested capital. Moreover, lower investment amounts than a traditional investment Incas lower management fees.

Unlike blind pool Investments which maintain rigid guidelines, higher costs, and require commitments, the alternative co-investment solution does not require investors to pay management fees in a commitment period before deploying the capital.

In addition to this commercial real estate investors in co-investment ventures enjoy the benefits of lower performance fees and flexible control and governance.

Benefits of co-investment in commercial real estate

There are several benefits to co-investing in commercial real estate alongside seasoned institutional investors. Some of the advantages of this approach are:

1. Affordable investment amounts

Traditional commercial real estate Investments have high barriers to entry. It is a capital-intensive investment accessible to only well-funded firms and accredited investors. As a result,  there is a higher risk of significant losses.

Moreover, the deployment of significant resources in assets limits the investor’s ability Tu diversify their portfolio. 

However, co-investing in commercial real estate allows an investor to concentrate a fraction of their equity. As a result, co-investing democratizes commercial real estate by allowing even small and average-sized investors to enter the world of property investment.

In addition to this investment, fee charges in co-investment models are often lower compared to blind pools and private equity funds. Therefore co-investors in commercial real estate can secure higher returns on investment.

 2. Diversification and access to wider opportunities

Accredited investors and firms often have access to sophisticated deals and opportunities in real estate growth areas. As a result, individual investors, are deprived of these transactions.

But, co-investment in commercial real estate allows average investors to partner with these institutional investors and opt-in on such profitable transactions on a deal-by-deal basis.

Co-investment platforms utilize in-house local managers and resources to locate, analyze, and underwrite deals comprehensively.

Hence the individual investor can delegate the burden of due diligence to the real estate managers and experts. This is because such professionals specialize in real estate investment and have the competence to unlock the full potential of each investment. 

Furthermore, co-investing allows smaller investors to access lucrative opportunities across different geographical markets, property niches, and investment blueprints. Therefore, investors can strategically allocate capital in the most desirable and dynamic market conditions.

 3. Preferential debt

Sophisticated accredited investors enjoy preferential low-cost debt from banks, retirement funds, and life insurance companies. However, these tax savings are not available to individual investors. Therefore co-investing allows average investors to enjoy the benefits of preferential high-quality debt. Co-investors can restructure their finances to gain more returns and make their investment more feasible.

 4. Favorable terms of investment

The co-investors participate in commercial real estate transactions alongside institutional investors. Hence, they gain insights into the overall pipeline of the transaction including how their capital is allocated, and the degree of certainty of the outcome. Moreover, a direct exchange of information with the fund managers enhances a greater degree of transparency.

It also allows the co-investors to gain more control over the scale of their own and their rights in the negotiation of the transaction.

 5. Management flexibility

In commercial real estate co-investment ventures, the responsibilities of day-to-day operations are shared between the primary investors and the co-investors. Institutional investors are seasoned professionals. Hence, they are more experienced in property management. Since commercial real estate transactions are complex and time-sensitive, co-investors can pass on the property management tasks to institutional investors.

Some of the important factors to consider in co-investment in commercial real estate

A Co-investment model is highly suitable for unlocking portfolio diversification and myriad investment opportunities. However, to maximize the potential benefits of co-investments in commercial real estate, the following factors are indispensable:

1. Track Record

It is crucial to comprehensively assess the track record of past deals and in-house capabilities of the co-investing platform. The management must possess a stable track record in commercial real estate investments across various markets and strategies.

Furthermore, the team must have a solid background in efficient and prompt management and mitigation of property-level risks. In addition to this, the management must accommodate seasoned in-house real estate veterans.

This demonstrates their efficiency in conducting due diligence accurately. The expertise of real estate professionals also ensures their ability to leverage the key market dynamics and investment mandates.

2. Strategies and objectives

 The evaluation of the existing portfolio’s niche and its composition is crucial to identify the investment strategies going forward. Investor needs to analyze their portfolio to determine which asset types, risk profiles, or geographies are unstable.

Hence, they must focus on the opportunities that align with strengthening the need for those volatile assets.

As a result, the investors can focus on properties that can potentially strengthen their portfolios and align with their long-term goals. This also prevents the investors from pursuing every co-investment opportunity that arises.

3. Ownership and Control of co-investment in commercial real estate

An investor might face confusion regarding their degree of ownership and control of a property. Therefore, it is ideal to gain clarity in the terms of the partnership documents before entering into co-investments.

Furthermore, the investor must enquire about the possible scenarios when the investment platform will dissolve or critical investment decisions will be taken. Therefore a co-investor must negotiate the terms to ensure a legitimate and stable ownership structure. This will safeguard and regulate the interests of the co-investors.

4. Liquidity

Commercial real estate is inherently an illiquid class. This is because a large portion of the returns is spent on the property’s operational expenses. Furthermore,  additional transaction costs and management fees consume a significant portion of the returns and sale proceeds.

Hence, shorter investment horizons do not allow asset value appreciation.

5. Asset management

With the right team, co-investment can streamline the day-to-day asset management tasks with the help of property managers. These professionals can oversee every aspect of property management that otherwise requires time and resources. Some co-investment platforms undertake several tasks ranging from property maintenance, and tenant management, to permits and paperwork. Hence, co-investing in commercial real estate allows the co-investors to enjoy passive income without their active involvement.

Is co-investment in commercial real estate the next big thing?

In the fast-paced, competitive environment of commercial real estate, co-investment models have expanded the pathways to myriad investment opportunities in the market.

For individual investors who lack the resources and capabilities to access institutional high-quality assets and undertake intensive asset-level due diligence, co-investment in commercial real estate provides an extensive base of options regardless of their budget.

Moreover, co-investment is an attractive alternative to blind pool fund investments. With co-investment strategies, investors can navigate through the transitional real estate investment landscape and diversify their portfolio thereby securing attractive risk-adjusted returns.