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Commercial real estate owners and investors: Three things you must know about the U.S. middle market

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Commercial real estate owners and investors: Three things you must know about the U.S. middle market

By: Chris Sadler, CEO of Allegiancy

November 03, 2014

Along with other real estate leaders from around the country, I recently spoke on a panel called, “Finding Opportunities in the U.S. Middle Market,” at iGlobal Forum’s Real Estate Private Equity Summit in New York. Because we represented diverse companies, it was interesting to hear how much we agreed on.

As background, the U.S. middle market in commercial real estate is considered the secondary and tertiary markets, where assets are generally under $50 million. It is quite different from the larger “gateway cities” market, which includes New York, Chicago, San Francisco and Los Angeles.  

Here are a few key takeaways about property ownership in the middle market:

iglobal-31)   The middle market is more the purview of smaller regional players, with knowledge on the ground.

As commercial real estate asset managers, we have to add more value, and we have to be more well-versed in the middle markets to make these investments work for you.

If you are in midtown Manhattan, one property to another isn’t likely that different.  In downtown Richmond, being just two blocks away can be mean radically different dynamics.

As owners/investors, you must have someone managing your asset who intimately understands the middle market.

2) Doing business in smaller markets requires extreme efficiency across operations.

While you can purchase real estate at better capitalization rates in the middle market, your actual realized yield will be much more dependent on your controlling operating factors.

For example, in a gateway city, a real estate firm could be managing 2 million square feet of office space in a single building.   In the middle market, we could be managing 2 million square feet across 10 buildings, possibly across three cities. All of a sudden, if we are not highly efficient in managing your operating costs, they quickly become a real drain on your portfolio returns.

As my fellow panelist, Ralph Rosenberg with Kohlberg Kravis Roberts, said, “Economy of scale strategy is an absolute ‘must’ on fragmented assets in secondary markets.”

3)   In the middle market, you have to work hard all day, every day to be successful.

iglobal-4In a gateway market, deals are regularly done valued in the hundreds of millions. If real estate pros can negotiate the difference of a few basis points, they can save $25 million.

Meanwhile, at the operating level in the middle market, it takes a long time to save $25 million.   We can’t do it with one good negotiation. We have to work hard all day every day. Some of the larger players get tired of keeping track of the nickels and dimes that make the secondary markets work.

Morgan Stanley panelist Paul Vosper said it well: “Efficiency is heavily time-weighted. The opportunity costs for pursuing smaller deals are very real.”

If you own or are considering investing in a middle market property, find someone who is very focused on operating efficiently in the middle market, and who has a track record of results there.

My company, Allegiancy, has demonstrated that middle market properties can be highly profitable, even when market conditions are difficult. We do it through excellent tenant service, careful operations, strategic evaluation, and efficient execution. As a result, we have generated positive returns across virtually all of our properties, consistently outperforming our peer group every year.

Related Press Releases:

Real Estate Private Equity Summit Speakers To Industry: “Middle Market Is Robust, But Requires Highly Efficient Operations” 

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