The 5 Building Blocks of the Next Big CRE Firm 

If you’ve clicked on this article, it likely means you want to know what it takes to be the next sensation in commercial real estate development and management.

Taking your firm to the next level is about strategy and cumulative effects — not a genius fix in any one area.

To effectively grow our businesses, we need an integrative approach that leverages our team’s aggregate skills to create a synergy of functional areas that strengthens our brand, value proposition, and decision-making capability. 

The results are improved project outcomes, greater access to capital, and more opportunity. 

Naturally, a future that promises these effects is too good to pass up. So, let’s look at five areas that work together to help you scale.

1. Sufficient capital

Not much can happen without sufficient funding.

It is the centerpiece of a successful CRE operation and requires a concerted team effort and strategic planning to fill and maintain the capital pipeline. 

So essential is raising funds that it’s both the direct and indirect objective of all our dealings. The following factors we’ll discuss are all intrinsically tied to and support generating capital.

1a. Demonstrating strong performance

To prove that we know what we’re doing, we need to show that we can deliver results. That said, how do we prove we possess that expertise and the potential to come through, rain or shine?

A principal point here is, we must leverage data to build a strong case for investment in our enterprise.

While other factors are important, as we’ll see, at the end of the day investors want quantitative, empirical evidence that we can generate a stable and satisfactory ROI.

To efficiently and consistently accomplish this, we need systems that monitor and collect data — across our enterprise — for acquisitions, revenues, operating costs, and more.

With centralized and organized data, we can quickly generate reports to incorporate into our pitch decks. And with those insights, we can make better decisions, which will further demonstrate our capability and expand our portfolios.

1b. Data-driven decision-making 

Business, like life, is a series of decisions.

Although we’re all prone to a few errors and hiccups along the learning curve, a conscious effort to leverage data and think critically enables us to consistently improve the quality of our decisions.

Fortunately, data is abundant, and with the right technological tools — and human insight — we can make choices that yield a net positive effect on the value of our businesses.

We’ve mentioned ‘data’ a few times up to this point — and we’ll do so a handful of times more — for good reason. 

Investors respect data-driven decision-making and the informed projections we’re able to offer based on evidence rather than conjecture or intuition.

Though there is something to be said for experience and gut feeling, in the high-stakes field of commercial real estate, we have to balance intuition with the scientific method.

1c. A strong brand and marketing

Data is crucial, but it’s not enough to differentiate from our successful competitors — and there are many vying for our investors’ capital.

Inspiring faith in our brand is the other side of the data coin to make a unified differentiator. Trust emerges from a combination of proof and an alignment of values and personalities.

Consequently, we need to build a marketing system and web presence to tell our story and share our values. An effective value-expression strategy incorporates a compelling website, social media, thought leadership, and public relations.

Aside from the pragmatic need to generate leads, we use effective marketing to position our brands and executives as credible experts in the field and to illustrate what drives us and how we act with integrity. 

Through this process of engaging with our target market, we gain a better understanding of our prospects and use that insight to refine our value propositions and messages.

The outcome is an alignment of values and expectations with investors and other stakeholders, which allows us to attract capital and talent — and take our firms to the top.

1d. An excellent management team, staff, and strategic partners

We saved the best — and most crucial — for last.

Your team, including yourself, is your most important asset. The people behind your organization are where your brand’s true value lies. There is no data collection or interpretation without the keen minds to plan, organize, implement, and monitor these measures. 

Additionally, trust is built not only on fact but also on a sense of rapport. In your pitches to investors and other partners, highlight the experience and personality of the members of your team.

Then, demonstrate how the unique capabilities and track record of each team member coalesce and resonate to create synergistic value that is greater than the sum of its parts.

Skip the growing pains

Rather than struggle through the growing pains, leverage the advice in this article to accelerate your growth. Rapid scaling starts with building your capital resources, showing your performance by the numbers, establishing a core competency in strategic, data-based decision-making, and conveying the value and personality of your team to forge trust.

To keep our NOI at its peak, or get it there, we need to understand tenant behavior — how our tenants think and act when leasing space for their business or residence.

Being aware of their expectations and concerns helps us design our offerings to ensure satisfaction and to keep our properties fully leased with high-quality tenants. 

Some occupant needs and desires are perennial, whereas others have very much to do with the pandemic and its ongoing economic, social, and health consequences.

Here, we dive into understanding tenant behavior and look at how to address health concerns, deal with economic risks, and position your brand and properties to meet tenants’ needs.

Marketing your properties and brand

If your prospective tenants don’t know about your properties, or believe in your brand, you’re going to have a tough time filling your units.

In the 2020s, marketing and branding are crucial, more than ever, to cut through the noise, get eyes on your offerings, and establish credibility.

Your properties need to be in locations that align — in image and function — with your tenants’ values, tastes, and environmental/economic needs (i.e., sustainability).

As for the image part (that is, your brand position), most of that is expressed and absorbed in the online realm. Your web presence and tenant management platform are where users learn more about you, what you stand for, and how you interact with (in other words, treat) them.

For function, users need spaces that are modern (or at least up to date) and efficient, with high-quality, tech-enabled fixtures, furnishing, and equipment (FF&Es). 

In the area of sustainable design and operations, both function and image are positively positioned by their adoption. 

Sustainable design and operations strategies provide health benefits — clean air, natural views, and thermal comfort — that bolster productivity and mitigate the legal risks associated with sick building syndrome (SBS).

Admirably, tenants, as do most consumers today, expect the firms they enter business relationships with to be environmentally and socially conscious in all aspects of their operations. 

And on a pragmatic level, tenants want spaces that go easy on electricity and water.

Economic risk — caution in leasing 

Committing to a new or renewed lease is a hard choice for tenants in the current economic climate.

Market instability in the COVID aftermath, falling lease rates in some asset classes, and soon-to-rise interest rates are compelling users to negotiate for terms that protect their interests from economic risk.

When it comes to tenant behavior, tenants are demanding shorter, more flexible lease terms that will reduce their loss — or position them favorably — should lease rates or interest rates shift during the term, or if the tenant must break the lease for unforeseen external reasons.

The change from LIBOR to SOFR also lends some uncertainty in leasing and creates additional concerns that must be addressed contractually. 

Plus, the pandemic brought into focus the importance of the force majeure clause and the need for language that specifically describes the circumstances under which tenants can be relieved of their obligations.

For the owner-operator, the best advice is to address these concerns upfront. Proactively direct your legal department to prepare new lease agreements that offer fair terms that benefit both parties.

Coronavirus safety concerns

The threat of infection is yet another mounting influence on how tenants select and utilize their spaces, with the intent to protect their staff and transient users (clients, visitors, vendors, etc.) taking priority.

During the height of the pandemic, landlords and prospective tenants found new ways of showing properties, using AR/VR tech and video conferencing to conduct walkthroughs and guided tours. 

Accelerated by the circumstances, the adoption of digital documents and e-signing have rendered paper and pen obsolete, further enabling the leasing process to proceed without close personal contact.

Also, the need for social distancing and sanitary conditions are intensifying the demand and expectation for touch-free building systems, antimicrobial surfaces, and proper ventilation. 

Further, the emergence of part in-office, part work-from-home business models is amplifying the need for open, flexible space for focus and collaborative work.

To learn how to adapt and provide greater value, discuss these concerns with your current and potential tenants to better understand their needs.

Care fosters loyalty

Taking marketing, economic, and safety considerations into mind, you can develop your portfolio and leasing strategy to match the expectations and needs of your tenants.

When your tenants are secure in their contractual and economic positions, experience minimal operational costs, and have a space that meets their wellness and collaborative requirements, you’ll have an optimal occupancy rate and the lowest turnover. 

Commercial real estate debt typically comes with certain conditions or ‘loan covenants.’ These covenants vary widely depending on the lender and their preferences. However, most require borrowers to maintain a debt service coverage ratio (DSCR) of at least 1.15x to 1.25x. 

DSCR measures a property’s ability to fulfill its debt obligations from its cash flow. And should the debt exceed the income — in other words, the DSCR falls below an agreed-upon standard — lenders have the authority to seize a property. 

Even worse, they can demand the loan be paid in full immediately and without notice. As a result, commercial real estate owners are strongly motivated to anticipate and recognize financial trouble and know how to avoid it. 

Fortunately, there’s a way to forecast and minimize this real, though harrowing, possibility. Stress tests play a vital role in steering owners and operators away from potential ruin.   

What is a stress test? 

Stress tests are used in finance to determine how well assets and liabilities can withstand negative changes in the market. In real estate, stress-testing reveals how well a portfolio holds up when different variables that underpin its profitability are altered. 

While the name may imply a physical component in many industries, stress tests in CRE largely take place in digital forms, such as Excel spreadsheets or sophisticated data modeling software.  

This technique involves manipulating financial data of a property to simulate different hypothetical scenarios and noting the effects on net operating income (NOI). The computed results are then summarized in a decipherable format to inform decision-makers on potential outcomes if a critical assumption in a model is negatively impacted. 

What variables are tested? 

Although a variety of variables are introduced in a commercial real estate stress test, the following are the most commonly used to gauge the resulting impact on the DSCR of a real estate portfolio. 

Interest Rates 

A subsection of commercial real estate loans set the DSCR based on an interest rate, whether it is the interest rate of the loan or a rate tied to Treasury Bonds. 

In this instance, it is important to measure the theoretical effect of fluctuations in interest rates. Usually, the base interest rate of each property loan is increased across the board by 1 to 3 percentage points to simulate mild, moderate, and severe jumps in the cost of interest. 

If a rate jump sends a property into the negative, it’s a clear sign that the property is highly susceptible to interest rate increases and therefore must be monitored by the owner or operator closely. 

Vacancy Rates

For the remaining subsection of commercial real estate loans, DSCR is calculated by dividing the NOI of a property by the monthly loan payments. 

Vacancy rate affects NOI, and that relationship implies that a vacant portion of a property cannot generate revenue to pay the debt service and operational expenses. Even if a property is 100% occupied, financial models will factor in the cost of vacancy as a line item in the operating budget, usually at a rate of 5-7% of the rent amount. 

But during a commercial real estate stress test, these vacancy rates are increased to double or even triple the base amount. Extreme stress tests may even set them to 100% to see what would happen to the DSCR if all tenants of a property were to break their leases. 

What’s the point? 

Stress-testing vacancy rates gives operators an idea of just how high vacancy rates can climb before expenditures surpass revenues. If they know the property will be cash negative at a 60% vacancy rate, they can reconsider their marketing approach to improve occupancy. 

Rental Rates 

Lease rates are the last major variable in a commercial real estate stress test. It’s a crucial metric because the amount of rent received contributes directly to the income generated. 

Rental income underscores the ability of a property to meet its debt obligations. Therefore, by determining the rental rate at which a project would be cash negative, an operator has a specific marker to track and prevent future adverse consequences. 

For example, if a stress test reveals rental rates below $3 per square foot would lead to financial losses, commercial real estate owners and operators can encourage their brokers to push for rates that exceed this threshold. Owners may also improve business operations and decisions to ensure they stimulate sufficient demand to secure optimal lease rates.

Stress test requirements

Stress tests cannot be done in isolation and require a certain amount of information about the property or portfolio. In fact, the more property and portfolio data an owner or operator collects for this purpose, the more accurate a commercial real estate stress test will be. 

Thus, in preparation for a stress test, it’s best to have all past financial statements, pro formas, and the following details: 

• The type of commercial loan. 
• The loan amount. 
• The net operating income. 
• The appraised value.
• The date of appraisal.
• The capitalization rate. 
• The original loan to value.
• The interest rate spread.
• The basis of rate index.
• The current interest rate.
• The current loan balance. 
• The principal and interest payment amounts. 
• The minimum debt-service coverage ratio requirements. 

Owners and operators who gather this extensive set of data points and incorporate them into their stress tests typically generate the best insights. 

When in doubt, find out 

Success in commercial real estate depends on the interaction and intersection of a number of factors, including rental income, interest rates, and key market conditions. Stress-testing provides commercial real estate owners the unique opportunity to understand and anticipate what contingencies could expose their portfolios. 

Short of being a crystal ball, stress tests provide valuable foresight that operators can leverage to optimize their methods and steer clear of crushing losses. That is, they are the best tool for commercial real estate owners and operators to manage risk and be proactive in building financial legacies. 

 

Loss of business income became an all too common occurrence at the outset of the COVID-19 pandemic. 

Internationally, businesses were forced to shut down to check the transmission of the SARS-CoV-2. Even worse, the business income (BI) coverage they had purchased to mitigate the losses…covered nothing. 

This unfortunate exposure occurred because there were (and still are) few insurance companies extending BI coverage for loss of revenue during a pandemic. “You’re on your own” was the implied message when policyholders demanded financial sheltering.

But commercial real estate owners and operators concerned about being caught in limbo in another pandemic have recourse besides insurance companies. This article delves into the three primary practices that can flexibly cover financial losses. 

Savings

The most viable option to insure against the loss of business income is savings. 

Setting aside a certain percentage of commercial real estate income has rescued many owners and operators who were hit with unexpected financial woes. 

The greatest benefits of using your own savings to offset the loss of business income are flexibility and immunity from red tape. Substantial savings eliminate the dependence on an insurance company — especially their schedule or interpretation of what is covered or otherwise — or haggling with a third-party processor in order to receive crucial resources. That is, such funds can be pulled on demand. 

The only drawback of using savings is the length of time required to accumulate funds sufficient to alleviate a medium- or long-term loss of revenue. 

Increased Security Deposits 

Increased security deposits have also emerged as a practical strategy to insure against loss of business income from non-paying tenants. 

Prior to the COVID-19 outbreak, credit grade was inversely proportional to security deposit requested — so, on average, the higher the credit grade of a commercial tenant, the lower the security deposit threshold a landlord would set. 

Yet when the pandemic unfolded and forced even AAA tenants to default on their rents, this implicit industry standard no longer seemed applicable. Now, commercial real estate owners and operators are implementing stricter security deposit standards that require large cash commitments. 

The rationale behind this latest condition is, should a tenant or business default, there will be more money available for landlords to recoup. That said, states or local jurisdictions may restrict landlords’ autonomy in this regard and cap security deposits. Therefore, it’s best to check with a legal representative before you set the fee. 

Rent Guarantee Insurance 

Rent guarantee insurance had largely been popular among residential real estate landlords even before the first reported case of COVID-19 infection. Unfortunately, their CRE counterparts had limited access to this insurance product pre-COVID-19.

However, in the wake of the pandemic, several companies have introduced options for commercial real estate owners and operators to receive similar protection — to which the intended consumers have responded with enthusiasm.

CRE landlords have widely adopted rent guarantee insurance because of the absence of a ‘physical damage’ requirement in order to approve a claim. This stipulation was the basis for most insurance companies’ decision to limit business income coverage during the pandemic. 

Fortunately, rent guarantee insurance can remedy this imbalance and cover the landlord if a tenant misses a payment — either successively or intermittently. Additionally, the landlord can add the cost of this insurance to rent so the tenants bear the expense instead. 

The only potential downside to rent guarantee insurance is the narrow scope of coverage. As this is a newer product in the U.S., companies are offering to insure loss of rent for just six weeks to six months. 

Nonetheless, this increasingly popular policy can provide a concrete buffer against loss of business income. 

Shift the Burden, Ease the Woes 

COVID-19 has shown business owners that there are certain events and contingencies that insurance won’t cover, such as the loss of business and rental income due to government-mandated shutdowns. 

To prevent future gaps in coverage, commercial real estate owners and operators must be prepared to shift the burden of protection back to the other parties involved, specifically the tenant and the landlord. 

Fortunately, there are a few mitigation tactics to de-escalate the impact of gaps in coverage and increase your chances of compensation. Saving aggressively, raising security deposit requirements, and purchasing rent guarantee insurance coverage are proven ways you can offset potential losses. 

Still, only time will tell which approach will be the most effective: BI or DIY. 

“Never invest in a business you don’t understand.” — Warren Buffett.

Gathering sufficient knowledge before each investment decision is crucial in efficiently building your portfolio, optimizing performance, and managing exposure.

The importance of these choices is highlighted when commercial real estate investors consider allocating capital in private funds. These real estate pooled funds fall into two categories: open-end and closed-end funds.

Closed-end funds have a fixed pool of assets and predetermined end date, along with a defined return target. Generally, no capital is added or withdrawn. In practice, most of the real estate funds are closed-ended. To exit, investors must sell their units to another investor seeking to take a position. In other words, closed-end funds offer close to no liquidity. 

In contrast, open-end funds have constantly fluctuating portfolios since investors can enter and exit at any time during the fund’s existence. No termination date is set. Therefore, underlying assets constantly evolve following outflows and inflows of capital. 

In this article, we will discuss the characteristics of and main differences between open-end and closed-end real estate funds, and how these investment models can support your unique financial objectives.

Closed-end funds: Profile, strengths, and limitations

A closed-end real estate fund is an investment fund with units and term predetermined. Investment in this fund is limited to the capital to be raised initially, and only open during a defined subscription period. 

Upon the manager’s receipt of commitments, the fund is closed and new investors cannot be added. Most closed-end funds are either listed as REITs (Real Estate Investment Trust) or unlisted but reserved for institutional investors.

What are the exit strategies for a closed-end real estate fund?

To recover capital in a closed-end real estate fund, you will either have to sell your participations to a willing buyer (‘over-the-counter’) or wait until the fund’s assets are liquidated. 

Both scenarios highlight closed-end funds’ lack of liquidity. Also, closed-end real estate funds usually have lock-up terms of 10 to 20 years.

What about the returns?

Return strategy in closed-end real estate funds primarily involves the appreciation of the underlying assets and their sale at term by optimizing them — such as construction, renovation, cost, and management structure — rather than focusing on the units’ income streams.

Therefore, returns in a closed-end real estate fund are predictable: The strategy of the fund is driven by executing a core business plan, with the expectations of profitability well known to its investors.

Open-end funds: Profile, strengths, and limitations

With no termination date, an open-end fund continually accepts subscriptions while adjusting its strategy and asset allocation. When there is a net inflow of new money, the fund manager invests it in additional underlying assets. 

In case of an outflow, the fund’s portfolio is rebalanced. That said, few real estate investment funds are open-end.

What are the exit strategies for an open-end real estate fund?

Real estate funds with an open-end structure allow investors to enter and exit without restrictions. Fund managers may, however, impose an initial lock-up period so that the base assets can be allocated to the fund without disruption.

Afterward, investors who wish to exit may sell their units to the manager, who has the underlying investments to fund their redemptions. In summary, open-ended structures offer greater flexibility and liquidity.

What about the returns?

Income strategy comes mostly from the fund’s underlying unit cash flows. Managers seek assets with steady, recurring income over time. 

Due to their focus on capital appreciation rather than development, open-ended real estate funds are considered to offer relatively lower total returns while carrying a lower level of risk.

Performance during market downturns: Open-end or closed-end?

Effect on open-end real estate funds

Open-end funds can suffer from a panic effect driven by the economic context where investors are eager to exit quickly. Consequently, the most liquid assets are sold to finance redemptions, often at a lower market price. 

These circumstances can trigger severe losses and imbalances in the fund’s portfolio, leaving the remaining investors in a difficult position.

Effect on closed-end real estate funds

Closed-end funds are relatively immune to this problem. Investors who wish to exit will have to find buyers in a very limited secondary market. Fund managers, on the other hand, are not required to sell the underlying assets. As a result, investors willing to hold their position will not be affected by a ‘panic selling’ effect.

In general, closed-end funds have shown excellent performance during economic recovery periods.

Keep your investment objectives in mind

Both open-end and closed-end real estate funds present pros and cons. Open-end funds provide greater flexibility and liquidity, thus minimizing risk. Consequently, returns are overall lower. 

Closed-end funds, in comparison, require lock-up terms acceptance and hence no liquidity, allowing their managers to focus on maximizing the fund’s objectives and performance. And in a stressed economic climate, the balance of the portfolio is protected from the risk of a forced sale. 

In practice, your choice will also be highly affected by the nature of the underlying units and the manager’s allocation strategy, subject to current market conditions. 

Regardless of the fund’s type, remember to conduct thorough due diligence on its manager prior to making any investment decision. It will allow you to assess the fund’s capabilities and forecast its performance. 

Ultimately, your choice should reflect your objectives, after taking all factors into account, including risk tolerance, time frame, liquidity, and tax considerations.

Some new investors look at the stock market and tend to assume that everything, from GDP to commercial real estate values, track closely with its overall performance. 

That is, if the stock market is up, then commercial real estate is up. Likewise, a bearish stock market should also correlate with a downturn in fortune in commercial real estate. 

Investors naturally use stock market performance as a blanket metric for a particular sector because the status of the equity market indicates the aggregate business mood of all investors. 

Though, depending on several factors, their collective sentiments could alternate between confidence and doubt at any given moment. This sudden shift in their investment outlooks is at the heart of market volatility.

In this article, we’ll show you how to bulletproof your portfolio against volatile markets and why the risk factors for real estate are completely different from those for stock market and bond investing.

The Risk Factors for CRE, Stocks, and Bonds

Volatile markets are especially dangerous if you make poor decisions as a result of them.

Some often seen examples of uninformed investment decision-making include liquidating all assets even though the fundamentals are still sound, funding investments with too much leverage in an effort to time the market, and hoarding an unsustainable amount of alternative investments as a contingency.

Though risk is a natural part of a boom-and-bust cycle, the factors that drive the stock market down don’t always affect commercial real estate.

In research published in the Pension Real Estate Association magazine, Greg MacKinnon analyzes how six common risk factors, including GDP growth and change in bond spreads, have different correlations with various asset classes. MacKinnon writes, “How much of the real estate market is driven by the stock and bond markets?“

Not much. 

Using quarterly returns from Q2 1984 to Q2 2018, MacKinnon shows that only 2.3% of the variation of real estate returns is associated with the fluctuation in bond market returns — and only a minuscule slice (less than 0.5%) is associated with the variance in the stock market.

What does this mean for you as a commercial real estate investor? 

Securities have very little correlation to the commercial real estate industry, despite the widespread conviction that the two are intrinsically linked.

Diversify Your CRE Holdings with REIT ETFs

Diversification is a strong motive for many investors getting into commercial real estate in the first place. If you’ve allocated your funds across multiple industries, your CRE portfolio might already be more “bulletproof” than you think.

A myriad of uncontrollable factors can put a real estate project in the red: shifting migration patterns resulting in decreased demand, natural disasters destroying businesses and homes, and more. 

Picking successful individual commercial real estate projects is sometimes just as difficult as picking successful individual stocks.

One way to overcome the volatile markets is REIT ETFs — i.e., investing in a fund that purchases real estate across many markets and areas. As an example, Vanguard’s REIT ETF has averaged roughly 9% since inception (and a whopping 34% YTD). 

Essentially, REIT ETFs allow you to hold on to a lot of different real estate assets without having to take on as much risk as buying a single property. In other words, you’re spreading your capital and risk across a variety of assets in different markets and geographic areas.

Even with this investment vehicle, you’re still exposed to the real estate market, but your investment is easily liquidated in the event that you find a project you want to pursue.

Invest in What You Know and Take a Long View

If you know your market, if you collaborate with partners you trust, and if the fundamentals of your investment are sound, you will very likely make money in even the most volatile markets.

And if you take a long-term view on the market — i.e., you don’t drop your assets in a recession — you’ll rarely lose money in CRE. Invest in assets that you understand and pay attention to the direction of the market to select assets and strategies that fit.

Then, when the market is pulling back, avoid short-term buying and flipping approaches and hold on to your CRE portfolio till the weather clears. CRE, like residential, consistently appreciates over the course of decades and, in the long-term, compensates for even severe market swings.

If your returns are falling and it really is the time to exit but you’re facing prepayment penalties on your conventional debt, consider defeasance as a strategy to replace the underlying collateral and stabilize your portfolio with Treasury bonds and other securities.

Hone Your Insight to Hedge Against Volatile Markets

The risk factors for stocks, bonds, and real estate do not precisely track with each other. And research demonstrates that the stock market is not an indicator of the commercial real estate industry’s performance. 

To keep your CRE portfolio humming throughout your investment lifecycle, hone your marketing insight, diversify your portfolio, and look past the horizon in planning your exit strategy.

Occasional remote work was part of the routine for many workers long before March 2020. However, the pandemic ensured that stay-at-home policies turned Zoom conferences and telecommuting into the norm.

Although the COVID-19 infection rate shows signs of slowing, many employees are not back to working on-site full-time — and have no intention of doing so just yet.

This unconventional work trend has deeply shaken commercial real estate, particularly large office buildings, which are now under-occupied. 

The high vacancy rate is not necessarily bad news, as it gives investors the chance to provide workplaces more suited to the current needs of both workers and companies.

Remote work is here to stay

Telecommuting was already popular with many organizations and their personnel long before the coronavirus pandemic.

According to a Regus study from 2017, 54% of employees worldwide were already spending half of the week working somewhere other than their company’s primary location — be it from home, a satellite location, or a client’s office. This transition to remote work developed organically and became a practical evolution of working.

Now, high-speed internet and advances in technology make it easier than ever to work remotely. For instance, the number of planning tools (including Trello or Slack), online meeting apps (such as Zoom), and file-sharing services (Google Drive, Dropbox, to name a few) have exploded in the past year. 

Teams can now communicate and manage projects seamlessly no matter their location. Besides, Millennial and Generation Z workers continue to demand a better work-life balance, so rigid work schedules are a major red flag for these younger groups. 

In recent Limeade research, 71% of respondents indicated they are anxious about returning to their workplaces because they fear losing the flexibility that came with the hybrid or work-from-home model they adopted during the pandemic.

Also, in the wake of the pandemic, workers have moved from metropolises such as New York, Chicago, San Francisco, and Los Angeles to mid-sized cities and suburbs with more space and lower real estate prices. 

But their relocation is not entirely voluntary. As their presence in the office is not required every day, they also need access to a dedicated — but more importantly — affordable home office space outside the pricey urban center.

These lifestyle and demographic changes have serious consequences for commercial real estate.

Some commercial real estate assets may become obsolete

Large single-occupant office buildings, where each worker had access to their assigned cubicle, were once a sign of prestige. But companies’ recent decision to adopt the hybrid model — i.e., employees working from home part-time — has dramatically reduced the occupancy levels of these properties and left large office spaces underutilized. 

As a result of the diminished need and demand for space, corporate tenants are calling for more flexibility and concessions from landlords to make these workspaces viable. 

Instead of identical cubicles, today’s office workers need access to informal collaborative spaces and private areas where they can focus on the task at hand without interruption.

Business owners seek these accommodations from landlords because the statistics generated during the pandemic demonstrate that there is still a need for conventional offices. 

While most workers would prefer to work from home at least two days a week, over 20% don’t see themselves working remotely. Further, 27% of remote workers reported that they regretted not being able to unplug at the end of the workday. 

Teamwork and collaboration also suffered from workers’ isolation and lack of in-person interactions, with 16% of respondents reporting these issues as their biggest struggle with working from home. 

Simply put, the office isn’t going away. And as the unemployment rate falls, office demand will rise.

New opportunities for investors

Commercial real estate must adapt to new lifestyle trends to thrive. Accordingly, we need to develop an offering that satisfies the needs of corporations and employees alike. Although traditional single-occupancy office building owners are facing challenges, the remote working trend offers new opportunities. 

Investors should consider diversifying their portfolios to include smaller offices in locations closer to where employees live. 

Corporations also need shorter leases that provide more flexibility. Unlike multi-year commitments, shorter terms (monthly, weekly, or even hourly) allow established companies, along with freelancers and startups, to share the same building and maximize its occupancy.

There is similarly a lucrative opening in coworking spaces — many home-fatigued remote workers are looking for alternatives. Additionally, remote work–friendly features are in growing demand in new condos and apartment communities.

Given these latest real estate dynamics, investors should consider converting existing assets to creative uses to attract new tenants. In some areas, empty offices may be replaced by mixed-use buildings featuring housing and coworking spaces. 

Elsewhere, new opportunities are taking more dramatic forms, such as repurposing large spaces for last-mile industrial uses to feed the immense demand for online retail distribution.

The office will live 

For many organizations, the pandemic triggered a prompt switch to a remote or hybrid model. Yet, work-from-home isn’t killing commercial real estate.

The immediate deployment of digital technologies kept businesses going. And now that the tools of quality telecommuting have been acquired, it’s time to look forward. Commercial real estate needs to adapt to take advantage of the opportunities this out-of-desk work approach provides. 

On March 16, 2020, millions of businesses in the U.S. faced two chilling realities: 

They had to shut down operations, close their doors, and turn away customers to slow the spread of COVID-19. And they learned their business interruption insurance wouldn’t cover ANY of the financial losses from suspending activities. 

How was it possible to have insurance for this seemingly exact situation yet receive no coverage? What could’ve been done differently to ensure protection? 

These are just two of many questions commercial real estate owners and operators have asked themselves over the past year and a half. 

In this article, we’ll cover how insurers let commercial real estate operators down and share strategies owners can use to protect themselves from future refusal of insurance claims. 

What is business interruption insurance?

Business interruption insurance, also called business income coverage (BI), is a type of insurance coverage specifically designed to shield a business against financial loss in the aftermath of a peril, such as a tornado, tsunami, theft, or fire. 

It protects a business from financial ruin by covering underlying operating expenses like rent, payroll, taxes, and lease payments. 

The anticipated compensation makes this policy ubiquitous among small- and medium-sized companies in all sectors.

As expected, business income coverage is also popular in U.S. commercial real estate, where nearly 90% of businesses lease — rather than own — their space. 

This occupancy trend is the reason commercial real estate landlords, like their commercial tenants, also suffered economic consequences (ranging from mild to catastrophic) during the government-mandated shutdowns. 

Why viruses are not covered 

Surprisingly, the insurance industry’s move to quietly dump insurance for virus-related peril started decades ago. When SARS broke out back in 2002-2003, nearly halting the Asian economy, insurers had to pay out millions of dollars in BI coverage settlements to their customers. Lesson learned!

Evolving from this massive hit to their bottom line, providers subsequently added to most insurance policies a blanket clause that excludes coverage for damage or losses due to viral or bacterial diseases. 

This calculated elimination meant that by the time COVID-19 was first confirmed on American soil, almost half of all insurance policies would exclude payments to businesses for pandemic-provoked economic losses. 

And thus a severe gap between the reality of COVID-19 and the limits of insurance emerged. 

In the fine print: why businesses flopped in courtrooms

Seeing their BI coverage claims being continually denied, owners across the country dragged their insurers to court, with over 1,500 lawsuits filed between lockdown and resumption of activities. 

Unfortunately for the aggrieved, verdicts for two-thirds of these cases were in favor of insurance companies. Owners couldn’t refute the virus-exclusion clause in their policies and the basic, almost unequivocal, language that required any damage to be physical for businesses to qualify for compensation. 

Judges at all levels seemed to agree that unlike fire, hailstorm, or a riot, COVID-19 failed to meet the ‘physical damage’ standard, as it is undetectable to the human eye. 

The key to winning

Thankfully, a few businesses were successful in their suits against the insurers. The victories of these victims offer case studies for commercial real estate to close the gaps in business income coverage. 

Rather than evade the physical damage requirement under the BI coverage, attorneys of the prevailing lawsuits proved convincingly — via a preponderance of evidence — the presence of COVID-19 on a business’s premises. 

These savvy counsels submitted results of testing of surfaces, air ventilation systems, and employees, which confirmed the deposit of this coronavirus variant. Their arguments were plausible, as proven by science. 

Because COVID-19 spread so easily, it would — in more instances than not — be detectable on-site, thus qualifying a business for a payout. Additionally, a handful of commercial landlords invoked the contamination clauses in their business policies. 

They categorized COVID-19 as a ‘pollutant’ capable of shutting a business down and swayed judges to recognize the virus as such. Their ‘pollutant persuasion’ allowed them to introduce a peril that was otherwise exempted from the policy. 

It’s also important to note that these lawsuits only prevailed because none of the insurance policies held virus-exclusion clauses. Nevertheless, these successes provide valuable insights that commercial real estate operators can apply to avert a similar ‘no-claim’ crisis in the future. 

For the future, odds are on divergent thinking 

Given the rarity of pandemics, one isn’t likely to strike anytime soon. But there will come a time when the limitations of business interruption insurance coverage will again become a contentious issue. 

Because despite the outcry over the ineffectiveness of business interruption insurance coverage in a pandemic, the fundamental insurance policies largely remain the same. And insurance providers appear keen to retain the current structure indefinitely. 

This refusal of insurers to accommodate a peril that is otherwise exempted from the policy means the ideal strategy to recover lost business income is to establish the underlying cause as physical.

Therefore, only through a more inventive, open-minded approach will commercial real estate owners and operators successfully protect their revenue.

While hypergrowth may seem like a nice situation for any business, managing it isn’t easy. 

The slightest misstep or hesitation in decision-making can mean a missed opportunity or strategic failure. 

What are we trying to say with the term ‘hypergrowth?’

A ‘hypergrowth startup’ is a new business that undergoes double-digit growth within a short period after launch. 

Companies at this stage welcome a surplus of new customers and, in turn, face a flood of production, sales, and unforeseen challenges. 

The CRE sector has witnessed its fair share of operators with just one property who went from managing a few units to overseeing thousands of doors in a surprisingly short time frame. 

But many have also collapsed under the weight of sudden acceleration. 

In this article, we examine the top five lessons that commercial real estate owners can draw from hypergrowth startups.

Move fast 

Hypergrowth companies move fast. 

They have few employees, no organizational silos, and little bureaucratic obstacles. 

A company with this setup is dynamic and can make strategic decisions with ease. 

Startups that move quickly respond to emerging crises and seize new opportunities while the windows are open. 

Commercial real estate firms can adopt a similar fast-paced approach by reducing paperwork requirements, decentralizing organizational hierarchies, and avoiding decision paralysis when evaluating opportunities. 

In doing so, real estate owners launching their operations can better position themselves to dodge transactional pitfalls, contract with the right partners, and secure the best deals. 

Stick to one goal

Hypergrowth startups tend not to focus on multiple, unrelated business objectives at the same time. 

Instead, they prioritize just one central goal that yields the best odds of survival at this stage of expansion. 

When employees and stakeholders aren’t clear on operational priorities, internal confusion and wheel spinning ensue. 

In contrast, a startup focusing on just one short-term goal, such as ‘onboarding new customers,’ will align its staffs’ activities and minimize internal discord. 

Commercial real estate firms can also set and single-mindedly commit to an immediate objective by picking one bench mark — like ‘assets under management’ or ‘monthly cash flow’ — and insisting everyone work toward its execution before progressing to the next milestone. 

Temper innovation 

Tech entrepreneurs know that innovation is a lengthy process that consumes immense amounts of money, energy, and personal resources. 

They also understand that developing cutting-edge tools is secondary to addressing present-day demands. 

In CRE, that often means prioritizing raising capital and building a lean operation that will get the venture to positive cash flow by the most efficient path.

Prioritizing practicality is why some startups avoid — or passively pursue — product and brand innovation during a whirlwind growth cycle (unless you’re in tech). 

Indeed, innovation is crucial to your long-term success. 

But starting out, you’ll need to balance technological advantage with the practical demands of generating sufficient short-term revenue.

Get organized 

There are plenty of success stories of startups adapting to the challenges of hypergrowth. 

Still, all of them could only manage that sudden, aggressive growth because they stayed organized. 

Early on in the execution of their strategies, successful company founders emphasize standardizing business operations throughout their growth phase.

This allows them to maximize opportunities, improve delivery time, and build a loyal following of clients and investors.

Likewise, in commercial real estate, the intentional organizers gain the edge. 

Disorganization in this dynamic market has devastating effects, such as lost deals, unexpected operating costs, and money left on the negotiation table. 

Commercial real estate owners can stay organized when scaling by incorporating the right technologies and internal systems to track paperwork, automate processes, and monitor properties. 

Teamwork is key 

Hypergrowth startups can’t accommodate internal disconnects. 

Rather, startup culture is centered on transparency, integrity, and communication. 

Smart founders promote cooperation among employees and focus on designing open and unifying organizational cultures and workspaces that facilitate collaboration.

The intent is to eliminate unhealthy internal competition, stress, and productivity blocks, which can derail a company’s momentum. 

In commercial real estate, harmony among all internal and external stakeholders is vital — anecdotes of once successful CRE enterprises left in shambles due to internal feuding and stubborn leaders are common.

Observe startups and build your playbook

Commercial real estate owners and operators can learn a lot from hypergrowth startups.  

Entrepreneurs successfully manage growth as a startup by moving fast toward one goal without being distracted by internal strife, unnecessary R&D, and disorganization. 

These powerful hypergrowth strategies provide commercial real estate firms the best playbook to prepare their operations for fast growth. 

Investment decisions can make or break your success. Elon Musk invested early in some of the most successful and innovative companies of the last 25 years: PayPal Holdings Inc., SpaceX, DeepMind, Tesla Inc., and The Boring Company, just to name a few. 

The diversity and profitability of his roster demonstrates that his investment decision-making process can be applied to a range of industries, including commercial real estate.

If you’re wondering how to invest in commercial real estate to maximize your ROI, it’s time to ask yourself: What would Elon Musk do?

Here’s a look at some of the strategies he’s used when making wildly successful investment decisions.

 

Diversify

One thing stands out about Elon Musk’s investment decisions when you run through them one by one: The companies are vastly different from one another.

Consider the companies mentioned in the intro and you’ll see a payment processing platform, electric vehicle manufacturer, and a commercial space explorer. 

The entrepreneur invested in these companies after achieving his first success with an online phone book called Zip2.

There’s no pattern to the types of companies he’s chosen to invest in. 

Rather, he’s continually diversified — a traditional but essential strategy to reduce risk.

Commercial real estate investors often adopt the same approach. 

We diversify by balancing investments in single-family properties, multifamily, office buildings, and other types of real estate. 

A high level of diversification insulates your business from risk and supports long-term growth.

Consider the Public Good

Investors buy and sell commercial real estate to make a healthy profit. 

But it’s even more admirable when they consider the public good in their dealings.

Musk always prioritizes investing in companies that promote the public good. 

For example, his AI company’s mission is to ensure that all of humanity benefits from artificial intelligence — not just a privileged few.

Musk lives by this commercial-plus-altruistic principle.

When Puerto Rico suffered a devastating storm, Hurricane Maria, he took a voluntary stake in rebuilding the territory’s power grid.

Yes, profit is the bottom line in commercial real estate. 

But, as Musk’s career demonstrates, financial gain and public good can coexist under the same corporate umbrella. 

Weather the Storm

Looking back at his track record, we see many of Musk’s investment decisions look like strokes of genius. 

But that wasn’t the case when his ventures were fresh and the companies were still journeying toward success.

PayPal, as ubiquitous and successful as it is today, was voted the worst business idea of 1999.

Tesla and SpaceX have also received heavy criticism at times, even though they’re generally considered successful companies now.

No commercial real estate professional wants to stick with a bad choice. 

However, when you’re confident in the long-term viability of an investment that isn’t going well at the moment, make sure you persist through the criticisms and downturns. 

 

Get Your Hands Dirty

Elon Musk is notoriously hands-on with his investments. 

He’s never been one to kick his feet up in the corner office and delegate to those beneath him. 

Instead, he gets involved in day-to-day operations to push his companies toward success.

When Musk first launched SpaceX, he cold-called rocket scientists to learn more about the industry. 

Today, that commitment to learning and understanding operations has helped him create a company worth billions.

As a commercial real estate investor, stay as close to the business as you can. 

You’ll gain a competitive advantage and make informed moves when you’re intimate with the markets you invest in.

Commit to Excellence

Elon Musk always ensures that “things are great” at his companies. 

This dedication to excellence drives the success of his investments.

Musk even uses a specific tactic to practice excellence on a daily basis. 

He focuses on what he calls “first principles” and boiling things down to their fundamental truths. 

As a commercial real estate investor, you’re operating in a competitive market. 

Indeed, finding a strategic advantage based on principle is the difference between a strong portfolio and one with lackluster performance. 

 

Skyrocket Like SpaceX

Musk is undoubtedly one of the most successful investors and entrepreneurs of his generation. 

There’s much that commercial real estate investors can learn from his career, motivation, and approach.

Your investment decisions are only limited by your willingness to look beyond the industry for lessons from leading entrepreneurs to apply to your commercial real estate vision.