Why Commercial Real Estate Investors are Hungry for Digital Assets
Our marketplace continues to surprise us.
We like to think we have a good handle on our audience; who is being drawn to online businesses and how to cater to their needs. But in the same way that 2020 has progressed so far, nothing is predictable anymore.
We’ve seen sizable shifts with large buyers—private equity and high net worth individuals being prime examples. Now, we have a new force to be reckoned with: commercial real estate investors.
These seasoned investors are taking notice of online business opportunities and are quickly staking their claim on some of our best digital investments.
To capture the “why” behind this burst of growth, I interviewed real estate expert Rainier Nanquil. He leans on his past as a seasoned commercial real estate (CRE) broker to give life to the opportunities waiting for CRE investors in online business.
Rainier’s interview reveals how commercial real estate investors may be new to our game, but with quick action they can seize online assets opportunities before others and build their strongest real estate and digital investment portfolios. Let’s hear what he has to say.
Before we get carried away with CRE jargon, we’ll have to define a few terms. You may be familiar with some of them if you’re into real estate personally but if you’re new to the game, then fear not! A handy terminology list is here:
Commercial Real Estate
Put simply, CRE is property used for business purposes. According to Investopedia, CRE is often leased to tenants to conduct business and can include “retailers of all kinds, office space, hotels, strip malls, restaurants, and convenience stores.”
Investopedia defines this term as “an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage.” The higher the LTV ratio, the higher the risk, and therefore the higher the interest rate for an approved mortgage.
Also known as “cap rate” for short, this formula aims to calculate the rate of return on an investment property. To calculate a cap rate, you start with the net income a property is expected to generate, “dividing net operating income by property asset value and [the cap rate] is expressed as a percentage.” The goal is to estimate potential return on investment (ROI) in the real estate market. For example, a $1MM property generating $100K in annual net operating income is a 10% CAP rate.
Turning to Our Own Real Estate Expert
Rainier got an early start in the world of CRE. Beginning in college as an intern assistant for a local CRE team next to his university campus, he jumped straight into the industry the Monday following his graduation.
That was the start of his journey to become a Senior Associate specializing in Capital Markets and Triple Net (NNN) Investment Sales. Rainier worked primarily in California but also nationwide where he sourced and brokered over $70 Million in sales transactions in excess of 127,500 square feet. He became an expert in 1031 Exchanges and net leased restaurants such as McDonald’s, Starbucks, Chick-Fil-A on a national basis.
He pushed himself hard in his career, working 60–80 hours a week. A self-proclaimed entrepreneur at heart, he began exploring his options. Like many in the online business industry, it was reading The 4-Hour Work Week that exposed him to online business and the notion of working less to live more.
Recalling his first perception of the industry, Rainier said, “I saw the similarities between the two industries [online business and CRE] and could see myself as a bridge to bring them together.”
This vision of becoming a bridge between two disconnected industries was what led him to seek out online business opportunities and brought him to the Empire Flippers team.
The State of the Commercial Real Estate Industry
Before we started talking about the similarities between industries, I asked Rainier to paint me a picture of the CRE industry as a whole. I wanted to find out if opportunities were plentiful or if competition was driving market scarcity.
Rainer began by describing where the industry was, “The commercial real estate industry is still transacting thanks to the lowest interest rates we’ve ever seen in history, along with a lot of major tax incentives in the industry, such as the 1031 exchange, property depreciation, mortgage interest write-offs, et cetera.”
Though it seemed like CRE would be a dreamland of opportunity, these positives came with a strong caveat:
“Transactions, in terms of volume since April, have been down about 70% from prior years…I would say that commercial real estate investors are extremely cautious right now, especially those involved in sectors such as hospitality, office, and retail. …In general, what’s going on in terms of the drop in volume is there’s a huge gap between the bid to ask price because sellers want last year’s pricing and buyers want deep discounts because of the pandemic.”
Despite there being plenty of financial incentives to buy and sell in CRE from an interest perspective, buyers and sellers are clashing. Adding that clash to the complexities of the pandemic is shifting the financing of CRE deals:
“Lenders were already disciplined because of 2008 and even more so right now with the pandemic, so you’ve got to be a real strong borrower (purchasing core real estate in strong markets and expecting low loan-to-values) if you’re looking at financing right now in commercial real estate. I would say before, let’s say last year and before that, 20 to 35% as a down payment was pretty normal with 65 to 80% LTV. Now, you’re probably expecting increased down payments with regular traditional financing.”
The push and pull between sellers and buyers to secure lucrative real estate deals has kicked up a perfect storm for CRE investors to look for new opportunities. People like Rainier, with one foot in each industry, could offer early predictions that CRE would start turning towards online business for new investment opportunities.
Why Commercial Real Estate Investors are Turning to Digital Assets
The movement of CRE investors to online business investment has been picking up speed. Rainier shared the momentum he’s seen just recently:
“We’ve done about four deals with different real estate investors in the past month: people that owned apartments, restaurant real estate, single-tenant net leases, shopping center owners, hotel owners. Just the whole gamut in terms of real estate investors, chasing yield and looking to diversify.”
Diversification and chasing yield may be obvious reasons to get into online business but one of the lesser-known drivers for CRE investors to pursue online business is surprisingly simple: future-proofing.
When introducing this concept, Rainer indicated the relative youth of the Internet and how, with the growth of giants like Amazon and Google, more people are going online for their purchases instead of to traditional brick-and-mortar shops or their local mall. This push to shop online is driving a macroshift towards omnichannel sales strategy.
Most of us engage with omnichannel shopping regularly without questioning the massive changes major companies have gone through to expand their reach. Buying something from Walmart online and picking it up in-store to bypass the two-day shipping, having to shop in person, or buying something on Amazon and returning those items to a local large retailer are all examples of omnichannel shopping in our everyday lives.
The struggle of brick-and-mortar retailers to keep up with e-commerce on their own is a strong indicator to CRE investors that they have no choice but to consider investment opportunities within the online space. Whether through an omnichannel or pure online play, selling online nowadays is almost essential.
In no way does this mean CRE investors are “stuck”.
If anything, this forward thinking bunch is used to operating from a half-full glass perspective and is eager to go after online opportunities.
Lucky for these investors, their world of CRE is not entirely different from various online businesses. Rainier’s side-by-side comparison shows just how much overlapping potential CRE investors can use.
Side by Side: CRE vs. Online Business Monetizations
Rainer set the stage for the industry’s overlap by starting with buyer personas.
“If you go to our website, you see the six types of investor profiles: Newbie Norm, Do-it-Yourself Dave, Flipper Fred, Strategic Sally, Portfolio Paul, and Investor Ivan. Virtually the same investor profiles exist in real estate, such as the flippers, syndicators, general contractors, private equity, and so on.”
The similarities in buyer personas tell us that buyer goals stay more or less the same. Investment strategies cross over with the ultimate emphasis being on executing strategy profitably, rather than the means of getting there.
Here are a few crossover examples and how real estate stacks up against online monetizations.
Net-Lease Real Estate vs Content-based businesses
“Content businesses and net-lease real estate are remarkably similar.”
Net-lease real estate is where a tenant is responsible for one or more expenses. Net-leases come in a single, double, or triple net-lease. In the case of a triple net-lease, the tenant pays property taxes, insurance, and maintenance. Rainer focused on triple-net leases, also called “triple-net properties”, for his comparison as they’re known for “being relatively passive bond-like investments.”
“Just imagine your local Starbucks, Walgreens, or McDonald’s. That’s going to be your typical poster child for triple-net properties. A private investor like you or I own that real estate and the tenant, let’s say Starbucks, pays all of those expenses in addition to rent, so you as the landlord just ‘clip coupons’ (also known as collecting the rent) slow and steady during that 10-to-20-year lease term. There is no dealing with broken toilets or replacing light bulbs like you would in an apartment. Triple-net properties are going to be a lot more passive in general, but a lot harder to add value to because of these set lease terms…”
The value-add opportunities is where Rainier added content-based businesses to the comparison.
“If you have, let’s say an evergreen business with unique content that lasts for a long time, you can rest for a little bit since most of the heavy lifting work has been done. Obviously, there’s more value-add components than in real estate, because you can easily outsource new content, link building, conversion rate optimization, and changing ad networks, for example. But for the most part, it’s hands-off since you don’t deal with inventory taxes, or suppliers, so content businesses can be 90% profit margin in many cases.”
While both investment vehicles (triple net leases and content businesses) can be alluring due to their passive nature, content businesses beat their CRE counterparts due to the abundance of opportunities to scale with relative ease.
Apartment Investing vs Amazon FBA
When comparing investing in apartment complexes and Amazon FBA businesses, Rainier started where he left off—value-add opportunities. In his eyes, both of these investment modes had much greater value-add components.
He set up an example: “If you buy an apartment complex, you’re going to immediately rehab the units, raise the rent, and then refinance or flip. That’s because the tenant leases are so short, you can force the appreciation and add value relatively quickly. While with Amazon FBA, if you have deep access to capital and you can purchase an existing cash-flowing business from us, then you can purchase more inventory to stay stocked, launch more products and pay-per-click campaigns. In my opinion, you can scale to bigger numbers much faster with Amazon FBA.”
Rainier was quick to point out that if a business seller had limited capital or had made any mistakes in their ownership, like running out of stock, a prospective buyer would have the base of a great opportunity. The spot where a seller couldn’t keep up or make their next move would be the perfect starting place for a buyer to grow the asset.
Between FBA and apartment investing, the speed to realize ROI puts FBA in the lead. To understand how fast and how much ROI to expect between investment modes, I asked Rainier to walk through the numbers. This is where the comparisons really come to life.
Cap Rates: Commercial Real Estate vs. Online Business
Understanding the power of cap rates is an essential part of CRE investing. To really understand online business in light of real estate, Rainier spelled out how cap rates compare to our multiples:
“In general, trophy assets (assets with exceptionally high investor demand) in prime real estate markets will trade for 4% to 5% cap rates. In online business terms, we use “multiple” as an indicator instead of “cap rate,” so that’s essentially a monthly multiple of 240, using a 5% cap rate. So essentially, you would get your money back in 20 years, if all things stayed the same, not counting appreciation or tax benefits in real estate. So 240x monthly multiple is what real estate looks like.”
“In real estate terms and online businesses, online businesses go for 33% to 50% cap rates, meaning you can make your money back potentially within two to three years, obviously not including the value-add component and higher risk factor of online businesses. But if we look at our statistics at Empire Flippers last year, we sold 273 online businesses for over 50 million in volume. The average multiple across the board was 28x, some lower, some higher, but 24 to 36x, aka two to three years is what you could expect in today’s time.”
Two years versus twenty years to reap the same ROI is no small difference. However, that wasn’t the only prime opportunity for CRE investors:
“If you look at our comparable businesses that we sold a few years ago at Empire Flippers, let’s say back in 2017, you can see that monthly multiples were 2 to 3x less, so maybe an average of 25x monthly instead of today’s 28x monthly. What that means is multiples are increasing over time as this asset class matures with additional investor demand…It would not surprise me if the average multiples on online businesses go into 4 to 5x annual multiples in the near future, which makes 48x to 60x in the coming years being the norm.”
In the simplest of terms, online business is just starting out and should online investing stay its course, we’re due to see an increase in value of online assets. To obtain a fuller understanding, I asked Rainier to reveal what other potential was out there for CRE investors—was it just faster ROI and early opportunities or was there more?
How Commercial Real Estate Investors Can Invest Online
“Have you heard of the silver tsunami?”
Rainier’s question caught me off guard at first. We were in the middle of discussing the potential for real estate investors in online business when the conversation seemed to take a different direction. I had yet to hear of this mysterious tsunami so he jumped right into explaining its connection to investing.
“The silver tsunami…is the greatest wealth transfer in history that’s going to take place in the next 10 years. Basically, $25 trillion are en route to get transferred over from baby boomers to Gen Z, and if I were to guess what Gen Z, people that were born in 2000s and beyond, if I were to guess what they think is cool besides TikTok and Bitcoin, it’s probably going to be online business.”
It made sense. In the grand scheme of wealth transfers and future investing, we are all beholden to the preferences of younger generations. Rainier was right to point out that the generation born with the Internet would be most likely to pour its wealth into digital investments.
Anticipating the demand and investing habits of Gen Z isn’t the only reason for CRE investors to take notice of online business, of course. Citing the speed with which technology advances, Rainier said he wouldn’t be surprised if return rate changes were compressed into 10 years instead of the next 20–30 years.
To get into the online business game now is like buying an apartment at double digit cap rates 20 or 30 years ago, according to Rainier. CRE investors who warm up to the idea of digital investments are in a position to take full advantage of the coming silver tsunami.
For some reading this, it might all sound too good to be true. I thought this might be the case, so I asked Rainier what his advice might be for those who weren’t on board with online assets. He acknowledged that a relatively new asset class promising such strong ROI would seem too good for many CRE investors. However, with due diligence, many become sold on online business’s legitimacy and are then faced with an important question: “How do I get started?”
CRE investors worried about their ability to run an online business with no experience benefit again from the real estate market overlap. Rainer explained how this could be:
“It’s like buying your first investment property. Once you get the hang of it, you’re mostly coming back afterwards for more deals. You quickly recognize that this asset class can be run location-independent from anywhere in the world with most tasks easily outsourced for you. But it’s just like riding a bike…people come back after buying their first one once they can prove that that return in ROI is, in fact, legitimate and possible.”
To get started, all you need to do is figure out your priorities and find which business model you gravitate towards. Rainier advised, “It really just depends on what’s more important to you. Is it cash flow? Is it appreciation?”
In the case of a CRE investor ready to start their online portfolio, Rainier recommended a customer-tailored portfolio analysis with one of our business analysts. By setting up a call, CRE investors can go over the different business models and see how they fit into specific investment strategies. Advice would be available throughout the investment cycle so getting the most out of a new digital investment would be within reach.
The Future of Online Business and Commercial Real Estate Investors
It feels near impossible to predict the future, especially during this tumultuous time. But I asked Rainier anyway, for his best prediction of what was to come for real estate and online business.
“Commercial real estate is changing overnight right now. You’re seeing people move out of places like San Francisco since they can work remotely and no longer have to commute or pay high living expenses anymore. You see people shopping online versus going out to brick-and-mortar stores. Real estate will continue to evolve and will still be around, but I think the two industries go hand-in-hand.”
He added that this is only just the beginning for online business. The industry is now maturing and more financing options are on the horizon. “I think we will eventually have tax advantages, such as real estate’s 1031 Exchange,” Rainer explained, “allowing you to defer capital gains tax when you buy and sell. I think the market just needs to mature and time will tell. It’ll come sooner than expected.”
Ready to expand your portfolio with digital assets? Set up a call with our business analysts for a portfolio analysis and customized strategy to deepen your portfolio.