Institutional-grade real estate attracts attention from large national and international investors such as hedge funds, endowments, and investment banks. Historically, non-institutional real estate investors had very few options for investing in the best commercial real estate investments, but today that is no longer the case.
In this article, we'll take a look at the difference between institutional and noninstitutional grade real estate and explain how non-institutional real estate investors may be able to out-perform the big players over the long term.
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Institutional Real Estate Definition
To understand what institutional real estate is, there is no better source to turn to than Institutional Real Estate, Inc. (IREI). The organization was founded in 1987 and serves as a global nexus for intelligence, knowledge, and insights on institutional real estate.
According to IREI, institutional grade property:
"Includes various types of real estate properties generally owned or financed by institutional investors. Core investments typically include office, retail, industrial and apartments. Specialty investments include hotels, healthcare facilities, senior housing, student housing, self-storage facilities, and mixed-use properties (i.e., a property containing at least two property types)."
Institutional-grade real estate is Class A or Class A+ property that generally has minimal risk of deteriorating or becoming obsolete during the investment holding period because the properties are brand new, have state-of-the-art systems, and the best amenities. Institutional real estate is leased to regional or national credit tenants with above-average store sales or gross business revenues.
What are Institutional Real Estate Investors?
Institutional real estate investors are entities that invest tens or even billions of dollars in real estate on behalf of their shareholders or clients. Institutional investors can be thought of as the "elephant in the room" due to the price size of the investment they make and direct access to investment opportunities that non-institutional investors and the general public do not.
For example, buying a single self-storage property in North Carolina wouldn't be of interest to institutional investors. But, investing in a portfolio of self-storage projects in different parts of the U.S. directly from the developer definitely would attract institutional investment capital.
Institutional real estate investors are also well capitalized enough to play the long game in commercial real estate. According to GlobeNewswire.com, 87% of institutional investors expect more or similar investment levels in CRE this year compared to last year.
To be sure, many institutional investment firms expect a further drop and no recovery for an extended period of time. However, more than 50% of institutional real estate investors see new investment opportunities in the commercial real estate marketplace providing a hedge against inflation, risk management, and portfolio diversification.
What are Non-Institutional Real Estate Investors?
Non-institutional - or retail - real estate investors are those investing for themselves or a small group of business partners versus on the behalf of someone else. The IREI defines a retail investor this way:
"When used to describe an investor, retail refers to the nature of the distribution channel and the market for the services - selling interests directly to consumers."
Whereas institutional investors have direct access to opportunities and can by-pass the middleman, retail investors generally buy property through a commercial real estate broker, bank, or invest in a private equity real estate opportunity.
Both institutional and non-institutional real estate investors look for a return on capital invested. However, the reason why many retail investors purchase income-producing real estate is to plan for retirement or build a real estate portfolio that can be passed along to their children.
Accredited vs. Non-Accredited Retail Investors
- Non-institutional investors are also classified as accredited investors or non-accredited investors. In the context of a natural person, an accredited investor includes anyone who:
- Earned income that exceeded $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years, and reasonably expects the same for the current year, OR
- Has a net worth over $1 million, either alone or together with a spouse or spousal equivalent (excluding the value of the person's primary residence), OR
- Holds in good standing a Series 7, 65 or 82 license.
Other categories of accredited investors include:
- Any trust, with total assets in excess of $5 million, not formed specifically to purchase the subject securities, whose purchase is directed by a sophisticated person, OR
- Certain entity with total investments in excess of $5 million, not formed to specifically purchase the subject securities, OR
- Any entity in which all of the equity owners are accredited investors.
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Institutional vs. Non-Institutional Real Estate Investors
There are several key differences between institutional and non-institutional real estate investors:
- Institutional investors focus on larger investments (oftentimes $10 million or more for a single asset) while non-institutional grade real estate can be purchased by any investor.
- Institutional grade assets are "picture perfect" compared to other types of non-institutional grade investment properties.
- Because institutional grade assets are brand new Class A and Class A+ properties, there is little risk of obsolescence or deterioration during the holding period.
- Institutional grade real estate is leased to well-capitalized regional or national credit tenants compared to other investment opportunities.
- Specific markets or commercial real estate asset classes can see lower interest from institutional investors during an economic downturn.
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Benefits of Being a Retail Investor
At first glance it might appear that the odds are in favor of institutional investors. But more often than not the exact opposite is true. Because retail investors purchase real estate for themselves and not someone else, they can be much more agile and have access to a wider variety of commercial real estate investments than institutional investors do.
Smaller investments are easier to make
Retail investors have the option of investing in all types and sizes of real estate. Some generic crowdfunding opportunities start at just a few hundred dollars, while very attractive value-add self-storage investments begin at just $50,000. On the other hand, institutional investors by their sheer size may need to invest tens of millions of dollars in a single transaction.
Ability to play the long game
While institutional investors must provide their clients with quarterly and annual performance reports, retail investors can ignore short-term market corrections and invest for the long term. Because small retail investors report only to themselves (and sometimes JV partners) they have the ability to stay invested and play the long game. Institutional investors who trade in and out of property frequently can generate excessive fees that undermine portfolio performance.
Property prices generally do not change when retail investors buy and sell commercial real estate, which makes the market more liquid for the retail real estate investor. By contrast, institutional investors can and do have a significant effect on property prices because of the amount of money being invested. In the single-family housing market for example, institutional investors are buying 20% of all homes in the U.S., which is one of the reasons why housing prices are skyrocketing, according to The Real Deal.
Ability to hold cash
Because real estate markets are more liquid for retail investors, they are able to sell and keep cash on the sidelines until the right investment opportunities come along. On the other hand, institutional investors feel pressure to keep every dollar invested, even if the returns are sub par.
Institutional investors are stewards of other people's money and are forced to diversify to avoid risks that may be more perceived than real. Retail investors have the flexibility of focusing on commercial real estate property types that perform well through all economic cycles, including alternative investments such as data centers and self-storage.
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When people invest for themselves, they pay much more attention to the type and quality of investment and take a personal interest in monitoring the ongoing performance of the asset. Institutional real estate investors who deal with thousands of properties in a portfolio simply can't devote the time and take the same level of personal interest that a retail investor would.
Types of Institutional Investors
While institutional investors may have more investment limitations than retail investors do, they also have access to larger pools of capital to invest on behalf of their clients and members.
There are six main types of institutional investors:
Both institutional and retail investors can purchase shares of a mutual fund. Mutual fund portfolios may consist of equities such as stocks, fixed-income instruments like bonds, and money market funds. Mutual funds generate income for investors through periodic dividend distributions, capital gains when holding within the mutual fund is sold, and when shares of the mutual fund are sold by the investor.
A pension fund is a retirement plan that provides income for the retiree. There are two types of pension funds:
- Defined benefit fund: Employees contribute a fixed amount of pre-tax income, receive a fixed payout upon retirement. However, employees have no say in how the retirement contributions are invested.
- Defined contribution fund: Employee contributions are pre-tax and gains are tax-deferred until withdrawal begins. Two common defined contribution funds are 401(k) and 403(b).
Large institutional investment banks include JPMorgan Chase, Goldman Sachs, BofA Securities, and Morgan Stanley. Brokers and financial professionals in commercial investment banks may invest on behalf of themselves, clients, and assist corporations with financing commercial real estate investments.
Hedge funds pool capital from accredited retail and institutional investors with the aim of generating above-market returns for their investors. According to U.S. News & World Report, hedge funds as a whole often underperform the S&P 500, but some of the top hedge funds such as Renaissance Technologies and Bridgewater Associates have returned billions of dollars to investors over time.
Endowment funds are created to fund non-profit and charitable institutions such as hospitals, churches, and universities. Capital is raised from donations which is then reinvested in income-producing assets such as equities, bonds, and commercial real estate. Ensign Peak Advisors, which is the investment manager for assets of The Church of Jesus Christ of Latter-day Saints is the largest endowment fund in North America with about $124 billion in assets, followed by Stanford University, Harvard Management Company, and Yale University.
Insurance funds reinvest the money received as insurance premiums in stable income-producing assets such as bonds and institutional-grade commercial real estate. The largest insurance companies in the U.S. are Berkshire Hathaway, Anthem, Humana, and Progressive which collectively have a market capitalization of nearly $622 billion.
Benefits of Being an Institutional Advisor
The sheer volume of capital institutional advisors and investors have access to creates several distinct benefits:
Institutional investors pay lower fees and commissions than retail investors do because of the amount of capital being invested in a single transaction. The amount of money at play gives an institutional advisor more negotiating power to lower fees and transaction costs.
Resources & bulk purchasing
Bulk purchasing power is another benefit institutional advisors have. Earlier we mentioned that one of the reasons housing prices are skyrocketing is because institutional investors are buying so many homes at one time. It's more efficient for home builders to sell an entire subdivision to an institutional investor than to sell one or two homes at a time to a retail investor or owner-occupant.
Access to securities
Institutional investors also have access to venture capital investments and initial public offerings (IPOs) that smaller investors do not, even accredited investors. When an IPO is publicly listed, institutional investors often sell their stock when the share price to retail investors exceeds the offering price (the price paid by the institutional investor) when trading begins.
There are two types of real estate investors: institutional investors and non-institutional (or retail) investors. While both seek to generate income from investing in commercial real estate, it is not necessarily beneficial to be an institutional investor.
Because institutional investors must report quarterly and annual financial results to their members and shareholders, they are less able to play the long game the way a non-institutional retail investor can.
On the other hand, retail investors generally report only to themselves or business partners, smaller investments are easier to make and they can more easily focus on opportunities that provide the highest risk adjusted returns.
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