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There are two schools of thought on this very sensitive issue.
THE CORRELATION CAMP
The cap rates are correlated to the interest rates and must rise simultaneously. As interest rates increase, cap rates will also increase, and real estate values will traditionally decline. If this camp is correct, we will see a destruction of equity investments made over the last three to five years, since much of this exit underwriting was heavily weighted on stable exit cap rates. It will only take a 100–150 basis point move to turn a great investment into an equity impairment. The cap rates are not correlated to the interest rates. Cap rates are based on capital flows, confidence, and the historical spread between cap rates and risk-free rates (which are still high). Interest rates can increase, cap rates will not change, and real estate values will not be affected. If this camp is correct, we will see a continued bull run in real estate values and equity investors will be handsomely rewarded. THE NON-CORRELATION CAMP Our partners have chosen to embrace the view that interest rates and cap rates are, technically, correlated . In response, we are employing an upside hedge approach. We are underwriting to higher base case cap rates and working to see our investors’ principal protected through an 8 percent cap rate and beyond. Thanks to this approach, we will not be hurt if cap rates increase and will do better than projected if they do not. WHAT’S THE VERDICT?
HARD QUESTIONS YOU MUST ASK BEFORE INVESTING IN COMMERCIAL PARTNERSHIP DEALS
PART 1
Real estate has always been regarded as an equal opportunity wealth creator. However, caveat emptor (buyer beware), because real estate also can be full of scams. This is the No. 1 reason why smaller investors don’t invest, and the last reason why all real estate deals fail.
Here are a few essential questions to help cleverly identify the strategic risks and rewards associated with any real estate related investment.
HOWMUCH IS THE OPERATOR, THE PERSON MANAGING THE DEAL, INVESTING PERSONALLY?
When somebody comes to you promoting an investment opportunity, ask, “How much are the prospective fund managers investing personally?” If they don’t have a stake in the deal and things go wrong, they are likely to walk away from it.
IS THERE A HUGE UPFRONT FEE OR LOAD?
When you ask this question, the response you get will reveal the sophistication of the operator you are dealing with. Fees should be considered imagined, not a load or anything upfront in which they immediately take 10 percent off the top of your investment. If they are looking to take fees right off the top of your $1000 investment now, you are left with a $900 investment. That’s a bad deal.
WHAT IS THE EXIT STRATEGY?
Do not invest in a real estate fund that presents no clear-cut exit strategies for its investors. There are only two ways investors can get taken out of any commercial real estate deal: refinance or sell. Make sure you are getting on board with an investment group that is either capable of successfully closing a sale or qualified to get the property refinanced and get its investors out. Many potential real estate investors buy based on emotion, often fearing that they’ll miss out on a great deal. But you should never let fear drive you to make a snap decision. Do yourself a favor. Take a moment to ask these vital questions before jumping into a bad deal.
3 www.TheCommercialInvestor.com
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