David vs. Goliath: Why Small Private Real Estate Investors can beat their Institutional Rivals

In just a few decades, the commercial real estate space has become increasingly institutionalized.  Despite the fact that institutional investors continue to grow their market share, small investors still have many advantages over their large and powerful peers.

Many technologies and innovations within the commercial real estate space, including big data, information, analytics, artificial intelligence, robust new technology platforms and developing capital markets are putting pressure on the ability for investors to find yield.  We’ve see this same trend play out in the stock market, as algorithms are replacing even the brightest minds and arbitrage is becoming a thing of the past.

 

The Institutionalization of Commercial Real Estate

Commercial real estate is not immune to such changes.  Over the last few decades, the commercial real estate industry has been transformed.  Decades ago, very few institutions owned, operated, or serviced commercial real estate.  The space was dominated by local private investors and owner-operators. Now, large institutions dominate the commercial real estate space. These institutions include: REITs, hedge funds, pension funds, insurance companies, endowments, and sovereign wealth funds to name a few.  Institutional investors are changing the landscape by throwing money at technology and services that help them understand and manage their real estate investment holdings. This demand for data, information, analytics, and asset management platforms, coupled with technological advancements, has created the perfect environment for CRE tech to take off–as it has over the past five years.  This institutionalization and consolidation of money and power inevitably creates a scenario in which the small investor has little chance to compete.  However, there are still many situations where nimble entrepreneurs can still outmatch their hefty peers.  The institutions do have the advantage when competing with local investors for core assets in gateway markets.  This is primarily caused by institution’s relatively low cost of capital and girth of their wallets. However, in secondary and tertiary markets, where local knowledge and information can be the key to a winning investment, smaller players can still outmaneuver their institutional rivals.

 

David vs. Goliath

The Biblical story of David vs. Goliath shines light on the battle for commercial real estate assets.  I’m sure we’ve all heard this story, but if not, I’ll briefly summarize it.  The tale relates a story of the boy David who offered to fight the mighty 9-foot tall Goliath.  Despite the appearance of being overmatched, David was able to kill the 9-foot tall giant. We typically think of David as being the underdog.  In reality, the real underdog was Goliath.  David, despite being relatively small and weak, had a superior weapon to the size and strength of Goliath.  David had a sling and five stones, which to the trained fighter, is almost as lethal as a modern day gun.  Despite being challenged by a bigger and stronger opponent, David used the one superior skill he had and ultimately killed Goliath.

How Private Investors can Outmaneuver their Institutional Rivals

So how does this translate to commercial real estate?  First off, let’s state the obvious.  In this allegory, Goliath is the REIT’s, the hedge funds, and other institutional players with money, experience, and highly intelligent professionals who specialize in every aspect of the business.  David is the private investor with limited access to capital, limited resources, and limited personnel.  The bullet points below describe how the David’s of real estate can beat the Goliath’s of real estate.

 

  • Most commercial real estate properties are custom designed–meaning each property has to be understood individually in order to maximize its value.
  • Local knowledge can be the difference between success and failure. Local investors will have access to information that institutions can’t obtain.
  • Relationships still drive transactions. These relationships can give locals the first look at off-market deals. Small communities prefer to work with locals with a vested interest and solid understanding of the community.
  • Properties are heterogeneous and therefore a one size fits all approach to buying, creating value, and operating will not be successful or efficient. Small investors are more nimble and can adapt their strategy much more effectively than institutions.
  • Real estate information is still scarce and transactions are private. Local information gives the private investor an advantage.

 

These are just a few of the reasons why small private investors can outmaneuver their peers. The real estate business is becoming more institutionalized across all facets of the space.  As a result, it is more difficult now than ever to find good deals and make a healthy return.  It just means you have to work smarter and harder to locate and execute on deals.  At the same time, many of the new tools and technologies being developed disproportionately favor the real estate entrepreneur.

 

Tools & Technology Favor Private Investors

New tools and technologies are coming to market nearly every week.  These technologies provide the data and insights previously only available to the big guys.  Also, seasoned veterans and large institutions are slow to adopt and benefit from such tools.  The small investor can gain an edge by incorporating some of these tools into his business.  For example, several platforms aggregate and compile vast amounts of data.  Without these platforms, institutional investors would have an advantage over the locals do to the amount of data they collect.  A small investor with the same aggregated market data as the institution, plus local knowledge and relationships, coupled with the ability to run a more nimble operation, give the small investor a sizeable advantage.  A new capital raising environment, created by technology startups, enable private investors to fund transactions much easier and more quickly than ever before.  These newly-developed crowdsourcing platforms allow private investors the opportunity to market their offerings to tens of thousands of investors online. Go to CREtech to find a directory of CRE technology platforms.

 

Commercial Real Estate cannot be Commoditized

Another reason that the David’s of the commercial real estate business should continue to be able to compete against their rival institutional counterparts is that commercial real estate is not a commodity.  Commercial real estate will not be commoditized because properties are far from homogeneous.  Each and every property is different.  For example, each retail property has a number of unique characteristics which will ultimately determine its value.  No two properties can claim that they are the same, from the design of the property, to the access, visibility, retail synergy, location, and surrounding area.  Each property is unique, and therefore, a one-size-fits-all approach to real estate investing and management, will leave money on the table.  Local entrepreneurs are able to exploit these opportunities much better than institutions.

Institutions Stay Away from Small Assets in Secondary and Tertiary Markets

There are 5.6 million commercial properties in the US and 88% of these properties are 25,000 SF or less.  Institutional investors generally do not invest in commercial properties under 25,000 SF, except for single-tenant net lease properties.  Properties under 25,000 SF require too much management to be considered by large institutions.  Institutions need to deploy huge sums of money, and therefore, they are not going to waste their time on small deals.  It’s much easier for institutional investors to buy one 500,000 SF property than fifty 10,000 SF properties.

Half of the properties in the US are under 5,000 SF.  89% of commercial properties under 5,000 SF are owned by private investors with an average sales price in 2017 of $3.6 million.  Virtually no cross-border buyers or REITs operate in this small asset domain. Private investors can still dominate in secondary and tertiary markets and among small properties that require active management.

These are just a few reasons why the outlook for small investors is bright.  In addition, there is more capital chasing U.S. commercial real estate than at any point in time.  If you can find a great deal using your local knowledge and relationships, you should have no problem finding the funding.

Greg Barrett
Greg Barrett
Greg Barrett is the founder and editor of CREentrepreneur.