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How To Diversify Investments In Commercial Real Estate – Forbes

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Commercial real estate is among those asset classes that have the potential to offer stability of investment and competitive returns over the long term. While the general rule of thumb for any prudent investor is to stay invested for a longer duration, especially in commercial real estate, sometimes your goals might require you to invest in assets for shorter periods — a year or lesser. 

Short-term investing, while not advised, can be done intelligently, while diversifying your portfolio as well. No matter what term or tenure you wish to choose to stay invested for, diversification is as important in commercial real estate as in any other kind of investment. 

Here are the options available to an investor to diversify their commercial real estate investment portfolio.

Short-Term Vs Long-Term Investment in Commercial Real Estate

Before tackling the matter of diversification, it is important to understand what is called short term and long term with respect to commercial real estate. 

Short-term investments in most asset classes are under a year, but for commercial real estate a short-term investment would mean a duration of two to three years, while a long-term investment typically means durations of five years and above. 

Commercial real estate as an asset class is illiquid in nature and offers quantifiable returns only when long term investments are considered. That is the primary reason why it is advised to get into commercial real estate investments only if you are looking at longer tenures. Longer tenures help add on to the investment through capital appreciation by increasing the value of the asset over time. This translates to better returns for the investor over the investment period. 

Capital appreciation is the difference between the purchase price and the selling price of an investment. Since real estate is immovable and properties generally tend to be long term in nature, time plays a crucial role in increasing the value of the asset. That is why the very method of investing in real estate becomes for a longer tenure than other contemporary asset classes.

For any commercial property, the investment period for two to three years can offer a return of 3% to 4%, while gross yields across investment periods of five years or more can be from 6% to 10%, as per the 2021 statistics shared by Knight Frank India. 

Commercial real estate is a rather resilient asset class that stays insulated from sudden market changes, but at the same time is also quite responsive to positive trends in the market. The same can be observed by the quick comeback of the investment class even when the pandemic situation caused a lot of doubt and uncertainty in the market. Now that the differentiation between long- and short-term investments in commercial real estate is sorted out, let us look at how diversification can be achieved in commercial real estate .

Diversification in commercial real estate can be done in a similar manner for long-term as well as short-term goals. Let us outline the methods available for diversification –

  1. Multiple transaction sponsors/investment firms
  2. Multiple types of real estate
  3. Multiple property classes
  4. Multiple locations

Multiple Transaction Sponsors/Investment Firms To Diversify Your Investment

For investors who are looking to earn passive income, it is quite logical to approach different firms for investment. That will involve looking into the performance history of the firm and how well it has been delivering on the estimate of yields. 

  • Be careful of “promised” yields, since that is not a way a proper investment firm should advertise their capability. 
  • Look for the IRR mentioned on each asset listed by them and be clear about what the parameters are for arriving at the figure. Different firms will have different investment strategies and methods via which they seek out promising assets and how they assess the market. 
  • Make sure you do a thorough research on every firm before going ahead with anyone. For example, if you want to invest INR 75 lakhs, you might choose to split that investment amount with 3-4 different firms/transaction sponsors based on how their investment strategies are.

Multiple Types To Diversify Your Investment

In India, there are majorly four types of commercial real estate that are recognized. They include commercial office spaces, industrial floors, warehousing, and mixed use. With every kind of real estate comes its own return rate, popularity, and susceptibility to the demand in the market.

Office spaces

These are the most known and easily understandable forms of commercial real estate. They are created to cater to the unique needs of running a business. It can be general purpose wherein it can cater to marketing, finance-related businesses. It can also be specifically created to fit the requirements of a laboratory, a doctor’s clinic, or the like. Investors in office spaces generally benefit from long term leases because it is rather costly to move a business once it has been established in an area. 

The downside to such long leases is that rental increases might suffer a hit if the market is on a favourable trend. Secondly, based on the location of the asset, the office space might have to be outfitted with expensive add ons to entice newer and better-paying tenants.

Industrial floors

They can sometimes include warehouses – especially if you have encountered terminology from the US. In India, warehousing is generally treated differently from industrial spaces. Industrial spaces are mostly specifically built for the businesses frequenting the market in the area. Manufacturing units can be housed in such spaces, and they generally are in industrial hubs as well, with connectivity that allows for heavy transport commutation. 

As an investment option, industrial spaces are closely linked to the business that require them. Unlike offices, a business will only increase its involvement in industrial floors if it is serious about expansion. Generally, the lease tenure is similar to that of warehouses, from mid to long term.

Warehousing 

These picked up pace especially after the pandemic, with a rise of ecommerce. These are wide open spaces that are used to store goods, for manufacturing and industrial sectors, or as a waypoint in the supply and logistics chain of any business. 

Of late, in commercial real estate, warehousing has been a much safer bet, even if the comparative rate of return is lesser than that of office spaces and industrial floors. Some warehouses can even be made special purpose and they can have a longer lease term – from 5 years, up to 10 years. While such spaces offer stable returns, rental increase can be stunted.

Mixed use spaces 

These mean what they spell. They can be a combination of retail, warehouse, industrial purposes, while also allowing for dining, lodging, parking, and the like. Larger malls and shopping complexes can fall into this category. 

The yield of such spaces is an aggregate of the businesses that occupy the space. In such cases, sub-leases can also be involved wherein the investment firm deals with different owners that sublet the space to different businesses. 

The lease agreements of such spaces are multifold and rather complex. Based on the location and population density of the area, such spaces can have a great return on investment.

A mix of warehousing, industrial and office space assets is advisable for any portfolio, but you should also watch out for where the market is headed. That will help you allocate more funds to a particular asset type or pull back from another type.

Multiple Property Classes To Diversify Your Investment

If you have encountered advertisements for investing in commercial or residential properties, you might have come across terms like Grade/Class A, B, C, and D. Mostly, the C and D classes are not featured as prominently. It is important to understand what these grades are and how they affect your investment.

Grade A 

These properties are mostly new, less than five years old and are built matching or exceeding the accepted norms or standards. They are located smack in the middle of business districts or industrial areas and have top notch connectivity to other commercial hubs in the region. They are the least risky and generally offer the most stable returns.

Grade B 

These buildings are well-maintained, refurbished and might need some light renovations. They can be anywhere from seven years to 15 years old and are in or around the periphery of high commercial activity. The rents are comparatively lower than Grade A buildings but can offer higher return on investment as they are much more accessible to tenants. 

The risk involved is higher than that with Grade A assets.

Grade C 

These buildings are generally located away from business hubs and do not feature great connectivity. They could be up to 25 years old and will require moderate upkeep, maintenance, or repairs. Risk is higher, but it is also the class of buildings that might be vacant the least. 

Special attention should be paid to the lease terms and the conditions for the increase in the rent upon renewal. While these buildings can offer high returns based on income and growth, the returns can also be variable from year to year.

Class D 

These assets are something that most investors stay away from. Based on the boom/bust scenario of the market, these assets can either result in amazing returns or total loss on investment. They can require major overhauling to bring them back to market standards.

As an investor, a mix of Grade A and B assets can be good for an average portfolio, while only seasoned investors can venture into Grade C assets for growth opportunities.

Multiple Locations To Diversify Your Investment

The commercial real estate market is insulated from the stock or bond market but is dependent on the demand in the general real estate market and the associated businesses that require commercial properties. Thus, location matters a lot. 

Stable office markets can be chosen from metros like Bengaluru, Mumbai, Pune, Delhi while growth opportunities can be picked from nearby suburbs where the working population is growing in numbers. Another way to stabilise a portfolio is to look at long term warehousing and industrial spaces where your investment can provide a steady inflow of passive income.

Bottom Line

Diversification is important in any kind of investment and the same holds true for commercial real estate as well. A planned diversified portfolio can boost returns and reduce whatever little risk is present in commercial real estate investments. 

At the same time, you should also bear in mind that riskier opportunities can come with the hope of higher returns, but as an investor, you need to be clear about your goals and the time for which you can stay invested in an asset.

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Edmonton could be headed toward housing supply shortage, real estate industry leaders warn – CBC.ca

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Supply chain problems, rising interest rates and more people moving to Alberta could contribute to a housing supply shortage in Edmonton, according to multiple industry leaders.

These trends, plus the rising cost of construction, were front and centre during multiple panel discussions at the Edmonton Real Estate Forum — a large industry conference held at the Edmonton Convention Centre — on Wednesday.

“All things are lining up for there to be a housing shortage in Edmonton in 12 months,” said Rohit Gupta, president of Rohit Group of Companies.

Following a panel discussion on the multi-residential market, Gupta told CBC News that real estate developers may not be able to build houses fast enough to meet rising demand.

Supply chain snags

Multiple commercial real estate industry leaders, participating in a panel discussion on retail trends, said supply chain problems keep them up at night.

There are long lead times on mechanical items, including refrigeration, gas coolers and transformers — perhaps because of pent-up demand during the COVID-19 pandemic, said Jarrett Thompson, chief operating officer at Cameron Corporation.

The delays are resulting in more time-consuming and expensive commercial and residential projects, he added.

“Despite there being a market right now, a lot of the builders are pulling back, which is creating some major challenges,” he said.

Among the many challenges is a lack of nails, linked to the war in Ukraine, said Gupta, of Rohit Group of Companies.

“It’s everything,” he said. 

“At some point, we’re so numb to the pain.”

Few executives predict these problems will disappear any time soon.

Darren Quayle, vice president of Alberta client services for Oberfeld Snowcap, expects supply chains to get back to normal in 18 months to two years.

Population pressures

Statistics Canada data shows Alberta saw the most interprovincial migration during the last three months of 2021, marking the first time since 2015 that the province led the country in that metric.

Most of those people came from Ontario.

Gupta said most of the people moving from Ontario to Alberta have settled in Calgary, but Ontarians’ interest in the Edmonton market has been accelerating.

The relative affordability of real estate in Alberta is a key part of their decisions to move, he said.

“We’re seeing people [from Ontario] buying houses sight-unseen.”

During Wednesday’s multi-residential housing panel, Strachan Jarvis, managing partner of real estate investments for Toronto-based Hazelview Investments, pointed out that Canada welcomed a record number of immigrants last year but housing supply has not caught up.

“We simply are not building enough,” he said.

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Price fixing has sent Realtor commissions soaring in an already hot market, lawsuit alleges – CBC News

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Much of the discussion about Canada’s real estate market has been dominated by the meteoric rise in the cost of housing. 

But what’s often missing from that conversation is the parallel increase in what Canadians pay in real estate commissions nearly every time a home is bought or sold. 

For example, a brokerage representing a buyer in 2005 in the Greater Toronto Area would have earned a commission of about $8,795 on the average single-family home — while in December 2021, the buyer’s brokerage would earn about $36,230, or four times more on that same home, according to Dr. Panle Jia Barwick, a leading economist on the real estate industries commission structure. 

To put that jump in perspective, the median household income increased by just 14 per cent between 2005 and 2019, after adjusting for inflation. 

That discrepancy is just one of the points laid out in a recent lawsuit, alleging price-fixing and anticompetitive behaviour in Canada’s real estate market.

In the Greater Toronto Area, the average real estate commission exceeds $62,000 before tax. (Patrick Morrell/CBC)

The class-action case launched on behalf of Toronto resident Mark Sunderland on April 9, 2021, claims that some of the country’s largest brokerages, including ReMax, Century 21, and IproRealty Ltd. among others, as well as the Canadian Real Estate Association and the Toronto Regional Real Estate Board, have “conspired, agreed or arranged with each other to fix, maintain, increase or control the price … for buyer brokerage services in the GTA.”

Commission structures vary across the country, but typically real estate agents and their brokerage charge a percentage-based commission on the sale price of a home. In Alberta and B.C., it’s seven per cent on the first $100,000 and three per cent on the balance. In other parts of the country, commissions range between four and five percent. 

The allegations

While the seller pays the full commission, it’s split between the brokerage representing them and the one representing the buyer. 

Sunderland’s lawsuit argues that the agreement known as the buyer brokerage commission rule, created by the Toronto Residential Real Estate Board and Canadian Real Estate Association, effectively forces sellers of residential real estate listed on the Multiple Listing Service (MLS) to pay the commission of the buyer’s real estate brokerage.

Similar practices exist within many other real estate boards across the country.

This arrangement has thwarted competition in the market by pushing sellers to pay for something they would not pay for in the absence of this agreement, the lawsuit argues — and it negates the ability to negotiate the price or quality of the service.

Stephen Brobeck is a fellow with the Consumer Federation of America. He says with respect to commissions, the real estate industry functions as a cartel. (CBC)

“It’s not a typical smoky room conspiracy; it’s out in the open,” said Garth Myers, a partner in Kalloghlian Myers LLP,  the law firm that filed the case on behalf of Sunderland and anyone who has sold a home in the GTA since 2010. 

The effect of this alleged price-fixing can be felt by those who don’t offer the standard commission rate, said Barwick, the economist focusing on the real estate industry’s commission structure. 

The buyer brokerage commission rule “creates the incentive and ability for buyer brokerages to ‘steer’ buyers away from residential real estate properties where sellers offer lower than the norm buyer brokerage commissions,” she wrote as part of research commissioned by Kalloghlian Myers LLP for the case.

Merely the fear that this could happen is enough to pressure sellers into offering the standard commission, she writes.

The practice of steering is further enabled by Realtor.ca, which allows real estate agents and brokers to see the amount of commission on offer but hides the information from public view.

Similar lawsuit certified in the U.S.

Sutherland’s lawsuit is similar to a class-action case underway in the U.S against the National Association of Realtors and America’s largest real estate brokerages. 

The U.S class action, which was certified last month, also alleges that anticompetitive conduct has taken place within the real estate industry, causing U.S. home sellers to pay inflated commissions. 

Using hidden cameras, Marketplace producers found some real estate agents steering potential buyers away from low-commission homes, a practice that breaches the law. (CBC)

“Tens of billions of dollars are at stake,” said Stephen Brobeck, a senior fellow and former executive director of the Consumer Federation of America, a non-profit organization based in Washington, D.C., whose research has helped inform the U.S. case.

“In terms of commissions, the industry is striving to maintain a pricing cartel,” said Brobeck, noting it’s something that’s happening in the U.S. and in Canada. 

On the sale of the average Canadian home, which is now $746,000, the full commission — what’s split between the buyer and seller’s brokerages — amounts to between $26,330 and $37,300 before tax. In a market such as Toronto, the average commission exceeds $62,000 before tax. 

When Sunderland sold his home, he paid “the standard 2.5 per cent” commission to the buyer’s agent and their brokerage, his lawyer said. 

“His view, and the view advanced in the case is, the reason he had to pay [the 2.5 per cent] was because of this price-fixing conspiracy among the various brokerages in the GTA,” Myers said.

“It’s the market that sets the rate, not MLS rules or collusion between brokerages.”​​​​​​– Rui Alves, CEO iPro Realty Ltd.

In March 2022, the Canadian Real Estate Association and the Toronto Regional Real Estate Board brought a motion to dismiss the entire action as having “no reasonable cause of action.” That motion will be heard in the fall.

Another defendant in the lawsuit said he feels the case is without merit. 

“Our business is very competitive,” said Rui Alves, chairman and CEO of iPro Realty in a statement to CBC News. “It’s the market that sets the rate, not MLS rules or collusion between brokerages.”

iPro Realty does encourage sellers to offer the prevailing rate for the area — or may suggest offering a higher commission rate to the buyer’s brokerage in a slower market, he said. 

“This proves that in no way are our fees fixed but simply reactive to competitor fees in the area, just like any other competitive business would do.”

CBC News contacted ReMax and Century 21; while Century 21 Canada said it doesn’t believe there is merit to the claim, it would not comment further. 

ReMax said it wouldn’t comment, given the ongoing litigation.

Steering and real estate commissions

A 2021 Marketplace investigation into the issue of steering by real estate agents found that consumers’ fears around the issue are not unfounded.

To test if real estate agents would indeed steer buyers away from a low-commission home, Marketplace producers went undercover, posing as homebuyers looking for a home in Vaughan, Ont. As would-be buyers, the team asked three local real estate agents to book viewings at three properties on the market, including one offering only one per cent commission to buying agents instead of the 2.5 per cent considered standard for the area. 

While one agent was upfront about the low commission and offered to negotiate the purchase anyway, the other two agents did not tell the buyers about the commission — and discouraged or thwarted them from seeing the home. 

WATCH | Marketplace investigation into real estate ‘steering’:

Real Estate Secrets

7 months ago

Duration 22:30

Investigation catches real estate agents breaking the law to keep commissions high, hamper competition and block private sellers.

One of the agents steered the buyers by telling them the house was overpriced by $200,000 and said the owners would not budge on the price, which was not the case. The other agent told the buyers she was unable to book a showing and suggested the property might have tenants, a turnoff for many people wanting to move in themselves. The owners of the property told Marketplace they did not receive a showing request from this agent.

Further to that test, producers called 25 real estate agents across the country while posing as sellers interested in listing a home. When the agents were asked about lowering the commission rate for the buyer’s brokerage, 88 per cent of the agents warned against doing so. 

“Although they’re not supposed to do it, some agents may be very cognizant of what they’re getting paid and push their buyer to another home,” said an agent in Halifax.

“I have had agents say to me, ‘You know we’re looking at two houses and they’re both a good fit, but I’m definitely sort of massaging them towards yours because there’s more in it for the Realtor,’ ” said another agent in Winnipeg. 

The Canadian Real Estate Association (CREA) and Ontario’s regulator, the Real Estate Council of Ontario (RECO) would not talk to Marketplace about the investigation. However, shortly after learning about the findings, RECO issued a notice about steering to the more than 93,000 real estate agents, brokers and brokerages then under its purview, noting that such behaviour breaches its code of ethics.

“In addition to being illegal, the conduct undermines consumer protection, consumer confidence and the reputation of the real estate profession as a whole,” the notice said.

Still, it’s rare to see sellers offering rates lower than the standard buyer’s commission. According to Toronto real estate agent Alan Spivak, sellers offering commissions of less than 2.5 per cent to buyer brokerages in the Toronto area represented less than one per cent of total listings at the time of his review. 

“This is consistent with my experience for all residential real estate in the GTA since at least 2010,” he wrote in an affidavit included in Sunderland’s statement of claim.

How to increase competition

If there were no buyer broker commission rules in place, Barwick writes, services would become more competitively priced — buyers would pay for their own representation and could negotiate pricing or forgo the service altogether. 

This is already the case in the U.K. and Australia. There, buyers and sellers pay for their own representation and commission rates are lower.

In Australia and the United Kingdom, buyers and sellers pay for their own representation in real estate transaction and there’s more competition as a result. (Norm Arnold/CBC)

“That would also encourage sellers to negotiate more vigorously with their listing agents and those commission rates would most likely come down too,” Brobeck said. 

Brobeck’s own research has determined that “decoupling” real estate commissions in this way could drop standard rates by one to two per cent over a couple of years.

The Canadian Real Estate Association told CBC News it would not comment on the Sunderland case as it’s before the courts.

The Toronto Regional Real Estate Board, another plaintiff in the case, said it “has no involvement with and does not consider or discuss REALTOR® commissions.”

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Worry, buyer's remorse high as real estate market slowdown materializes – Ottawa Business Journal

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A wave of buyer’s remorse is taking shape in several heated real estate markets, after housing prices started dropping and the number of sales slowed over the last two months.

Realtors and lawyers in Toronto and Vancouver say they have noticed buyers looking at what options they have to get out of a purchase and sellers hoping to ensure one goes through because conditions have shifted dramatically from the previous highs and frenzied pace.

The country experienced a 25.7 per cent drop in the number of homes sold over the last year and a 3.8 per cent slide in housing prices between March and April, the Canadian Real Estate Association said Monday. The average home price last month totalled $741,517.

Such numbers have prompted some sellers to explore lawsuits to ensure transactions move forward and other purchasers to worry about the value of pre-sale properties they bought years ago but have yet to take possession of.

“With today’s real estate prices, there’s really no option but to go all in and if you’re going all in, and then suddenly you’re realizing that perhaps you made a bad bet and there’s a way out of that bet, you’re going to do whatever you can to get out,” said Mark Morris, a Toronto real estate lawyer.

In recent weeks, he has seen nine cases where buyers want to back out of deals but on Monday alone was approached by three sellers keen to use legal channels to keep purchasers from walking away.

Morris doesn’t call the encounters a trend because it’s unclear how many other lawyers are seeing the same spate, but three queries in a day is his new record. He used to see one case of that nature every few months.

“Purchasers are looking at the existing crisis, and in the best of times, they feel they overpaid, but now they have objective proof that they’ve done so because markets have started to pummel and fall and really shows no signs of slowing down,” said Morris.

“Many of those buyers are faced with the option of moving forward or upping and walking.”

People get “spooked” every time the market turns and explore what they can do about deals they signed, but few end up walking away because it’s hard to get out of such transactions, said Phil Soper, CEO of Royal LePage.

He thinks the exception to this pattern came in 2020, when the COVID-19 pandemic broke out and people wanting out of transactions had so many unknowns on their side.

Most buyers trying to end a deal this year won’t be successful because there is no legal way out, but such cases are also impractical for sellers, Morris said.

“Is a seller really willing to pursue a buyer that has no assets? Is the seller really going to go through three years of courts only to find that they have a judgment that can’t be pursued?” he pondered. “Are they really ready to put up the amount of money that it will take to pursue this to the ends of the earth if they’re able to resell? Perhaps not.”

In cases where the buyer has put money into a seller’s trust account, that money can only be released with a court action, the closing of the deal or a mutual agreement not to pursue the sale, said Morris. He’s seen buyers agree to give the seller the money, if the seller mutually agrees to end the deal.

If a deal ends, brokers can sue for their lost commission but not many explore this avenue because it’s “not a good look” to take legal action against a client, who might still turn to you when they try to sell the home from the failed transaction again, said Morris.

While Tirajeh Mazaheri hasn’t seen legal action in Vancouver, the Coldwell Banker Prestige Realty agent has seen buyer’s remorse and worry crop up among investors who purchased pre-construction homes a few years ago but have yet to take possession of them.

“A lot of those people are thinking, ‘Is the market going to be able to justify this price or keep up with the price I paid and can I get this money back if I want to sell in a year?'” she said.

The people who purchased in early rounds of pre-construction sales for a building are already ahead of the curve, but those who bought later will have to wait longer to break even or make a profit, she said.

Even though worry is at a high, Mazaheri and Soper agree the markets do rebound and homes are still a valuable investment.

“Anyone who bought a home in 2021 in this country, if they bought anywhere near market price, their home is going to be worth more in 2021,” said Soper.

“Will it be worth more one year from now? That’s harder to predict ? but even a year from now the likelihood of that home being worth less than it is today is smaller.”

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