Money mistakes are a fact of life. In a survey by consumer comparison website Finder.com, 78 percent of Americans confessed to making at least one financial gaffe.
Such mistakes typically carry greater consequences for high-net-worth (HNW) investors, though. One slip-up in a commercial real estate deal could easily cost millions of dollars.
To help HNW investors avoid expensive blunders, we’ve compiled a list of eight common mistakes they make in commercial real estate, along with strategies for sidestepping those errors.
HNW investors shouldn’t believe that they can handle the gamut of functions connected with commercial real estate alone, according to Matt Topley, chief investment officer at Valley Forge, Pa.-based wealth management firm Fortis Wealth LLC.
“In most cases, HNW people earn money due to their expertise in a particular professional field. The trouble occurs when then try to park that money in real estate,” Topley says. “Most of the time, they fail due to lack of industry knowledge and inability to execute as a landlord. It’s not because they aren’t intelligent.”
HNW investors should resist the urge to shoulder the entire burden of buying, selling, owning and operating a property, agrees Jeff Sica, president, CEO and chief investment officer at Circle Squared Alternative Investments LLC.
“While we absolutely respect our HNW clients and their business experience, we make it very clear that it is a mistake for them to conclude that they can do everything required for a deal on their own,” says Sica, whose Morristown, N.J.-based firm specializes in private equity real estate deals for HNW investors. “Solid deals require a solid team with multiple areas of functional expertise.”
HNW investors should build a strong team of professionals to guide their real estate investment decisions, including experts in real estate law, taxes, insurance, leasing and property management, according to Adam Finkel, principal of Tower Capital LLC, a real estate finance firm in Phoenix.
Booth says HNW investors should look at the big picture of a real estate deal, instead of focusing only on the expected returns. When zeroing in on the returns, it’s easy to overlook risky tactics such as assuming too much debt to achieve returns and being too lenient with underwriting, he says.
“Real estate is not a quick win. It is a long-term investment strategy,” Sica says.
Tax planning frequently winds up being an afterthought, Thomson says. For instance, she says, HNW investors might be eager to find a home for a pile of cash, but they may not have weighed the tax consequences of eventually selling a property.
Other factors that should go into tax planning include how the investor will hold the title and how the investor can shield himself or herself from liability, Thomson says.
Many HNW investors don’t thoroughly research the local market before investing in a property, says Nick Giovacchini, director of client services at San Francisco-based real estate investment service AlphaFlow Inc. This research should take into account local information regarding price-per-square-foot comparisons, cap rates, commercial construction activity, zoning regulations and economic growth, he says.
Owning a property goes beyond simply buying it. An investor must also figure out how the property will be managed.
“We advise our HNW clients that if they want to maximize the investment potential of the property, they are going to have to be thoughtful and deliberate in their management of that property and decide whether they will be adding substantial value or just sustaining a baseline condition,” Thomson says.
Key to this is ensuring that a well-qualified management team is in place, Sica says. He recommends asking these questions about a team that’s already managing a property or one that’s going to be tapped for that job:
· Are the team members organized, proactive and responsive?
· Will tenants be satisfied with how they deal with maintenance issues and emergencies?
· Have they properly budgeted to guarantee healthy cash flow?
“Tenants make choices about whether they want to stay,” Sica says. “When they do, they help make the project viable… . If they are unhappy, they walk away, and a great property can be abandoned.”