Alternative asset classes a riskier investment

Director of Commercial Lending , First National Financial Corporation
  • Mar. 23, 2016

14DarrylBellwood-FNFGenerally, investors in commercial real estate are familiar with more mainstream assets usually classified as multi-family or apartments, retail property and office property.

These types of assets usually dominate investor’s appetite since they typically provide safer investments and good locations in their respective municipalities.

Multi-family or apartments always offer up a stable return on investment since they have high occupancy rates and multiple tenants looking to occupy units. Both retail properties and office properties are usually located in high-traffic areas, attracting a mixture of the type of tenants that occupy space in each type of asset.

Office properties are usually located in core nodes of a municipality complementing the vibrancy of downtown cores which can also lead to attracting other businesses in the area. Each of these investments have different risk profiles but usually provide a stable rate of return on the owner’s investment.

Preservation of capital not guaranteed

For investors, the preservation of capital is not guaranteed, but usually not as big a risk as investing in alternative asset classes.

Alternative asset classes can take different forms ranging from garages, car dealerships, golf courses, self-storage facilities or hotels. While each differ in their risk profiles, they all have a high degree of associated business operations.

Take, for example, a car dealership. The owner of the dealership may also be the owner of the real estate and the operating business of the dealership is what ultimately pays the bills which may also mean the mortgage.

From a lender’s review, the risk profile on alternative assets is high. Extreme care has to be used when underwriting them, since the operations of the businesses is the revenue stream lenders use in their cash flow analysis.

The difficulty for a lender is the ability to separate the revenues and expenses of the operations from the real estate and finding a way to simply underwrite and review the asset.

Hotels, for example, have a high turnover rate since they specialize in providing short-term accommodations. Cash flows are not only dependent upon the daily rates they can achieve, but also on other supplemental income such as restaurants or room service and the meeting and banquet facilities usually found on site.

Wages not always attributable to real estate

However, hotel wages are not always attributable to the actual underlying real estate. The different services available at the hotel can be difficult to separate in order to ascertain a true underlying value of the real estate which the lender is trying to achieve.

To further complicate the underwriting, the lender needs to look at the annual occupancy rate for the facility as well as the overall average daily room rate achieved for the hotel.

Self-storage facilities have similar characteristics when they are being underwritten since they have occupancy statistics and average rental rates. They also derive income from other services such as packing and moving supplies.

They are usually located in more industrial areas where land costs have traditionally been lower. However, over time the facility may have benefited from condominium development that usually targets lower-cost land.

Self-storage facilities benefit from smaller condos

As more and more condominium projects have been developed in municipalities, self-storage facilities have benefited from the smaller unit sizes in condominiums and owners who do not want to part with their belongings. It is easier to rent a storage facility than to part with belongings.

These have tended to drive up the rates on the rental units thereby adding significant cash flow. The real challenge, similar to hotels, is to understand the expenses attributable to the real estate and not the business.

Another thing for certain on these types of assets is the degree of management. Since all involve operating businesses, they have a high degree of management associated with their operations.

If you are looking at investing in any of these assets, be prepared to spend a high proportion of your time looking after the asset.

Speak to your lender if you are looking to find ways to finance these assets. While they are not as mainstream as the usual commercial real estate investments, financing is always available.

Darryl Bellwood is the Assistant Vice President, Commercial Financing with First National Financial, Canada’s largest non-bank lender. Darryl provides commercial mortgage financing solutions for all types of commercial real estate…

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Darryl Bellwood is the Assistant Vice President, Commercial Financing with First National Financial, Canada’s largest non-bank lender. Darryl provides commercial mortgage financing solutions for all types of commercial real estate…

Read more

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