“You Make Your Money Going In”: 12 Essential Investing Principles from a Commercial Real Estate Career

By the time your escrow closes on your commercial real estate investment, the most important part of your hand has been played.  Your future Cash-on-cash and Internal Rate of Return numbers will be pegged to the price you paid at the purchase.  Your ability to build property reserves and pay off your note will happen depending on the amount of rent you are able to collect relative to the cost of your monthly debt service payment, which is pegged to your purchase price and your loan-to-value ratio.  Your debt will balloon in 3, 5, 7, 10 or more years based on the term of your note.  Your assumptions about changing interest rates, rental rates and occupancy rates will bear out (or not) and impact the return on your project.

There are certainly many ways to add value to a commercial property but if you commit the cardinal sin of paying too much to start with then it will be an uphill battle to achieve great success with the property.  The challenge is that it is the goal of every Seller to make you overpay.  Sellers, in my experience, generally believe that their properties are worth more than the market says that they are worth.  Humans are very prone to seeing their properties (investments and home) as an extension of themselves and more valuable than they are.  As I scanned Loopnet this morning (a daily ritual) I saw 80 listings in my trade area and all of them were overpriced in my opinion.  As I write this, we are at the top of the market cycle so this is not particularly surprising.

Just the same, we have purchased (syndicated) $16MM worth of investments this year (a shopping center and apartment complex in Modesto, CA) and are in another escrow currently and deals can be found in all parts of the market cycle if you are alert and prepared to execute.

Being prepared to execute is not unlike golf, to use a mediocre analogy, in that it requires that you have the right clubs and know when and how to swing each one.  Below are 12 essential investing “clubs” and some advice on how to swing them:

1.  The Perfect Plan–Knowing What to Invest In:

There are a host of investment strategies that can be deployed with varying levels of risk and return.  Before you start investing, you should think carefully about the geography, asset type and deal size you are looking to invest in.  Our strategy has been to buy multi-tenant assets near Stanislaus County (where we live and work).  By buying locally, we have an informational advantage over our competitors that may be located out of the area.  For larger assets, our competitors are largely based in the Bay Area or Los Angles Area.  It may be that people who can spend $10MM on a shopping center would rather live in Marin than Modesto.  That works out for us.

Our geography is very important to our model because we will invest in multiple asset types but are focused on properties that are nearby and that we can manage closely.  If a tenant unexpectedly vacates, we are in a much better position to overcome this with direct effort than if the property were hours away or in a different state.  Also, we know every street and owner in our local market and can spot opportunities that others miss.  Also, we buy quality.  We buy near down-towns and we buy on busy streets with great visibility.  We would rather pay a fair price for a great property than a great price for a fair property.  Quality properties in core locations hold their value much better than poor quality properties.  Also, we look for properties that are in great locations but in need of repairs.  Over the years we have honed our skill at making cost effective repairs that have a big impact on lease rates and value.

Your job as an investor is to hone your strategy over many years.  Your strategy will be a personal symphony of market timing, desired asset type and locations that you understand.  Great investors zig while others zag.  Work to form your own opinion and invest in what you understand, rather than following the herd.  The herd always runs off the cliff eventually.  If you build your opinion and approach, you are much more likely to see the warning signs in advance.

2.  Get a Great Deal—Knowing How to Find Good Investments:

Finding great deals is something that you have to work on everyday and it should be a key goal to be in a financially sound enough position that you can work diligently for many months and years at finding and buying great deals.  We have made good strides in this direction over the last few years as we have built a firm that manages millions of square feet of commercial real estate for other owners and where we have a property services pipeline.  We have developed a great team on the accounting and property management sides that supports this mission.

A seasoned business owner once told me “The first ten years are the hardest.”  It was a bit of a joke but in the investing world and in the commercial property services world you simply have to put in the time to develop the relationships and property knowledge to operate at a high level.  As we enter our tenth year, we still have a way to go and have made several pivots over the years but the vision is clear, our team is solid, and we come in to work each day knowing where we are going and what we have to do to get there.  It is a great feeling.  Many of the early and mid-years were not this way and we gutted them out.

Beyond putting in the time, finding good investments has involved a lot of outbound calls.  We send letters and cold-call owners and also scan the listings each day and make calls.  We write an offer or two every month.  My experience is that we know a great property when we see it.  A great opportunity keeps me up at night as I mull through my strategy.  I often drive past key properties frequently and sit in the car in the parking lot and watch the foot and car traffic.  It takes a while for the vision to fully form.

As you become more established in the investment business, good investments will start to find you.  If you have the ability to close and a track record, you will quickly be added to lists from investment brokers and get exposure to off market deals.  At this point, I get a call about an off market property every few weeks.  Down the road, this call volume is likely to pick up.

3.  The Trial Balloon—Putting in the Offer:

Putting an offer in is its own science.  We try to make the refundable deposit on the larger side so the Buyer knows we are serious.  We work to understand from the Selling agent or the owner what it will take to win the property and how much competition we are up against.  We work to make our time terms as aggressive as possible.  When we need to, we can complete due diligence in two weeks.  We work to have our financing strategy lined up in advance.  We frequently include a resume in our offer of the projects we have recently purchased.  Sometimes we take a commission and sometimes we work directly with the Selling agent and let them have the commission if we think it will help us stand out from our competition.

4.  Team Up—Develop a Vetting Process:

 I have the luxury of having a business partner who I started in the business with.  Before we put an offer in on a property we have often discussed it (read: argued about it) for hours.  We both have veto rights and will have thoroughly discussed the tenants, the market, the pricing, the risk factors, financing, etc. by the time we make a decision.  We both have internal compasses and operating styles that are different but complimentary.  These are some of my favorite discussions.  Sometimes we table it and then revisit it the next morning.  The result is that I think we make great decisions.  In most cases there is not a clear path and clear answers.  We are managing a host of risk and reward and timing factors.  The best deals exist because there are not clear or easy answers.  We get paid a premium to solve hard problems.  The trick is to have the toolkit and experience to solve the problems and to pick the right problems to work on.  We are great at solving three to five specific problems and we look for deals where we can focus on those problems.

“Margin of Safety”:  When we buy properties with a value add component that we know how to solve, we are building risk tolerance into our investment.  Markets go up and down but if we know how to increase a properties value by 20% in less than a year by working a leasing or repairs and rent increases plan, then we will be buffered against a downturn.  Also, we are almost always willing to pay a premium for 10 year fixed financing so that we are not susceptible to interest rate risk or a lender calling our note when we are not ready.  We are in this for the long term and willing to give up a few basis points to avoid a 2010 type catastrophe.

Overtime, it is very important that you develop a spreadsheet you believe in.  For institutional and larger investors this is commonly an ARGUS run.  We still use a spreadsheet model that we created ourselves and has been honed over many deals.  It calculates expected returns, including with a syndication model that may involve waterfalls or a promote interest.  When we work with investors, we work to achieve a double-digit cash-on-cash return as quickly as possible, ideally by year 2.  Depending on the property risk profile and value-add plan, these returns can range from 9% to 20%.

5.  Know Your Stuff—Understanding the Market

As a commercial real estate investor it is your job to understand the market and have a PERSONAL opinion about where it is headed.  If you can speak intelligently and based on experience on what you expect to happen and when and why, you are well ahead of the person who is just investing with the crowd.  You should be able to intelligently defend your perspective.  In 2007, the market fell 40% in value over the next two years.  It would have been very difficult to forecast that large of a drop but commercial real estate moves in market cycles and there are a number of tools that you can use to understand where you currently are in the market cycle and which strategies you should deploy.  A great place to start is by digging in to the easily available public research.  See points 6 & 7.

6.  Get a Clue—Know Where You Stand in the Market Cycle

The commercial real estate market reflects supply and demand.  When there is a lot of space for lease, rents are low, and property values are depressed (Recession, Recovery).  When there is not a lot of space for lease then rents increase and so do building values (Expansion).  When there is very little space for lease, buildings get built and new space is created.  Eventually there is too much space (Hypersupply), and the economy goes down and the cycle heads back towards the bottom (Recession).   There are many property cycles.  There is a national property cycle, local cycles and asset type cycles.  All are supply and demand driven and supply and demand can be measured in macro and very micro ways.  The advantage to working specific asset types and in a specific geography is that you are more likely to be an expert on these micro trends.  The are subcurrents in a larger ocean and are easy to miss if you are not looking closely.  The commercial real estate cycle correlates with the Business Cycle,  though property trends tend to lag business trends because it takes time for businesses to decide to expand and to have the capital necessary to invest in expansion.

So how do you know which part of the cycle you are in?  Some good questions to ask are:

  • How do current vacancy rates compare to the long-term average?
  • How do current rental rates compare to the long-term average?
  • Is there any new construction going on?

If vacancy rates are low and rental rates are high then you are likely in the Expansion phase.  If new construction is occurring then you are nearing or in the Hypersupply phase.  During these phases you need to be careful not to overpay because the market will go down again.  During these segments, it pays to buy quality properties in core locations and with great visibility.  Quality properties are the last to go down in value and the first to rise.  Quality properties tend to attract and retain tenants.  We often look for properties in disrepair in core locations.  We see their potential and budget for repairs and vacancy while we improve them.  The upside comes when we move a property from getting poor tenants and low rent to great tenants with higher rents.

There are several great resources online.  Below are some great online market cycle indicators.

JLL produces a quarterly Property Clock which can be helpful in understanding market cycles and getting a sense of where your City is in the cycle.

Black Creek Group is a REIT that sponsors the research of Dr. Glenn Mueller, the godfather of market cycle research.  He was the first, in the 1990’s, to isolate the “physical” and “financial” cycles that drive real estate.  More info on this: here.

Green Street publishes the most well-known chart showing commercial property price fluctuations.  The chart below shows the value cliff dive that the market did in September of 2007, dropping 40% of its value in 2 years.  The index has been published since 1997.

The SIOR Commercial Property Index reflects property pricing but all shows the momentum of the commercial real estate economy.  Its score also considers development activity and local and national economic growth.

Below are some additional great forecasts and indicies:

7.  What Former Dry Cleaner?—Perform Great Due Diligence:

This is a more straight-forward aspect of investing but crucial to doing winning deals.  In this segment you dig into the financial model and make sure that you have captured all deferred maintenance you will have to pay for and look for risk factors that might not have been fully understood during the marketing phase.  Is the Net Operating Income truly what was stated or did they miss a few items, like the management fee or reserves for repairs?  What exactly is included in the NNN charges and is it appropriate for the market and is anything missing from them?  When properties are capitalized at 8% on purchase price, a missing $50,000 in net operating income will have a $625,000 impact on the purchase price.  You had better catch this before your due diligence period is over.  A re-trade is never fun and it is important not to develop a reputation for doing this each time, but if information was missing or new information is discovered, sometimes it is necessary.

Meeting with each of the tenants personally is among the most important parts of buying a property.  We look to asses if the business is successful and the business owner is truly committed to the property.  We ask if they plan to renew and what they like and do not like about the property.  We look to show them that we are partnering with them in this property and we care about their success.  Truly, their success is our success.  If we can make some minor improvements or help them in some way then we are glad to do it.  Often, their just knowing that they have a landlord that cares and supports them helps.

8.  Come Up with Some Cash–Raising, Deploying and Managing Equity:

You cannot be in this business without cash.  You must have money to put down deposits and make the down payments.  In commercial real estate, deposits are commonly $20-50K and down payments on properties are usually 30%-40% of the total purchase price and closing costs.  As we have built the business over the years we have often had to find creative ways to accomplish this including: seller financing, syndication, and private loans.  We have often re-invested part of our commission and leasing fees to create equity.  We have commonly looked for ways to earn sweat equity through leasing or sales work.  All of this is predicated on our sourcing great deals that we are sure we can execute on.  When you have great deals, there are lots of ways to accomplish them.  As one long-time investor once told me: “Success has many fathers, failure is an orphan.”  Everyone wants to be a part of successful deals, businesses and people but a failure or a bad deal will quickly vacate a room.  We are very careful to work on great projects that have margins of safety and are aligned with the direction of the market.

9.  Get a Loan—Sourcing Debt and Knowing What Type of Debt to Source: 

Take a banker, or five, to lunch today.  Commercial real estate borrowing is still very much a relationship-based business.  Lenders want to know who you are personally and see if you and your operation are the type they can do business with.  Banks have different appetites.  It is important to use the right lender for the right borrowing need.  Below is a profile of some key lending sources.

  • Small Community Banks:  Several of our earliest deals were done with a small local community bank.  This bank was family owned and was comfortable doing $200,000 to $500,000 commercial loans.  For our earliest deals they were a great lending source.  They knew us personally and were much easier to work with than a large corporate bank.  The rates will not be the best but you will get the deal done.


  • Medium Sized Community Banks:  We eventually started to work on larger deals where we needed to borrow $600,000 to $1,500,000.  We found another local community bank and built a great relationship with them and did several deals.  They had more capital to lend and were willing to work on larger deals.


  • Large Banks:  Recently, we got an $8,000,000 loan from Rabobank to buy Sylvan Square in Modesto.  We went to our community bank resource but they were not interested.  Rabobank is one of the largest in the world but still has a smaller bank feel.  They kept our loan on their books and originated it out of their Fresno location, which understood the valley and liked our strategy and story.  We are currently working on our next deal with them.  They were the right mix of being well capitalized but still having a community bank feel.


  • Top 10 Banks:  We have yet to get a deal done with a US Bank, Wells Fargo or Bank of America type bank.  In my experience they are not very entrepreneurial and more interested in working with huge companies rather than local investors.  I suppose I understand this logic from their side but it has not been helpful for us.  Of the “big banks”, Wells Fargo seems to be the most understanding of local investors and business people.  We are talking to them currently and I suspect we will work with them at some point.  They seem to be the best bank to grow with if you plan to build a larger platform.  They have different products and levels of banking as you progress through the investment levels to larger deals.


  • CMBS:  Commercial Mortgage Backed Securities:  We have bought and sold several properties that were in default and taken back but we have yet to borrow using CMBS.  This is “pro product” in that you do not have a bank or banker where you can go do workout if there is some sort of problem.  Our preference has been to pay a little more so that we have a “warm body” we can call.  I expect that at some point we will utilize CMBS but I expect it will not be for a few years.  In most cases it is worth giving up a little of your return spread to buy options in the future if you run into trouble.  We saw too many investors get punished or wiped out during the last downturn.


  • Seller Financing:  Seller financing can work great on smaller challenged properties.  When a seller cannot sell a property for the price they want using traditional methods, they will sometimes be willing to hold the paper.  This gives them a long term cashflow stream but also means they take on the risk of your failing.  We recently got seller financing on a challenged strip center, in a great location, that needed $150,000 of repairs.  The seller financed the building and we paid for the repairs as our down payment.

10.  Control Your Outcome—Property Management:

 Commercial Real Estate generally requires active property management.  Certainly, for the multi-tenant type of work that we do, great management is a must.  You can hire for this or develop it in-house.  We have developed it in-house but at a significant cost and with years of effort.  Having developed a significant third-party management business, we have the management software Yardi Voyager, Building Engines for vendor and property repair management.  We do regularly scheduled tenant interviews and property inspections where we look to spot problems in advance and address them proactively.  We get calls daily from tenants and owners with a small crisis on their hands and we have the systems and people to address those and stay on top of hundreds of requests and requirements.  We work to communicate with property owners three times monthly.  We have a comprehensive financial and property report, an additional mid-month property inspection report, and a scheduled call every month where we review the two reports and talk about upcoming concerns and goals.

If you are going to work with a third-party management company, some questions you should ask are: How often will you visit the property?  How do you handle property inspections?  Do you have a checklist you use each time?  How often will I hear from you?  What is your vendor management process?  Will I have a separate trust account for my property?  What will my statements look like?

11.  Keep the Cash Coming In—Property Leasing:

Properties do not have a purpose without tenants.  Tenants spend most of their waking hours at your property and see every little problem and opportunity for improvement.  They build a community at the property and form good or bad relationships with their neighbors.  Our firm does some of its own leasing and hires out some leasing.  As we have grown to work on more and more properties and we have had to build relationships with leasing agents.  There was a time when we had leasing agents in house and we may go there again some day but generally our firm does the renewals and uses outside firms for the leasing.  Leasing agents are the front lines of commercial real estate.  They earn their money with the tenants they know and the hard work and many tours they do.  I have really enjoyed working with great local leasing agents.

Sales:  Our background has been in investment sales and for some properties we do the work ourselves.  As we have grown to larger properties, we have also built relationships with investment sales agents.  This group is generally well paid and elite in the commercial real estate world.  As we have approached from the Buyer and Seller side, rather than the competing broker side, we have built some very good brokerage relationships and this is the group that sees deals before they hit the market.  This is the group that recommends to their Sellers that they work with us as Buyers.  Commercial agents can be very well paid but it pays to work with them as they can really help build your investment business.

12.  Move On—Knowing When It is Time to Sell:

 While you make your money going in, your biggest payday is when you exit.  Knowing when to exit is an artform.  Some of our deals are IRR driven and we get a bigger bonus based on the return that is achieved.  In these cases, it pays to sell earlier and deliver the best investor return possible.  The counterpoint to this is cashflow.  Getting the best investment return is great but cashflow pays the bills.  Our individual goals are to build up a long-term stream of cash that will pay us for the rest of our lives, whether we work or not.  Everybody retires eventually.

Generally, the best time to sell is when your value-add strategy is mostly complete AND the market is higher in the expansion phase.  Sell towards the top.  The perfect strategy is to buy troubled property at the bottom of the cycle, fix them as the market rises and sell them near the top.  This is generally a 3 to 5-year swing.  You do not have to do this too many times to have made some great money and had a great career.

Putting it All Together:

Commercial Real Estate Investment is a great 40-year career.  It is not a skill set that is learned quickly and on the whole, real estate is a slow business.  It takes years to find great deals to buy, great tenants to occupy, and the right market timing to buy and sell.  We had the luxury of working in the individual trades of brokerage and property management prior to moving into investing.  One of my core beliefs is that all the buildings you see are owned by someone and it had mine as well be us.  Real estate is a local business.  You have an advantage in the market you live in over people live an hour away or in other states.  If you take the time to learn the skills above you will find a tremendous stream of opportunity and a lifetime of meaningful work.  Good luck on your journey!

Written by Joe Muratore


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