How to invest in high-end commercial property

Buying real estate can be appealing because the investment is further removed from the stock market. But if you’re interested in large commercial properties, such as office towers, you’re usually out of luck. In most cases, you’d have to buy a publicly traded Real Estate Investment Trust (REIT) to get in on something of that scale.

This is changing, says Sam Sivarajan, head of investments at Manulife Private Wealth in Toronto. He’s put clients into a new type of fund that allows them to access direct buys made by institutional players.

So how does it work?

The first 75% to 85% is a portfolio of commercial properties. It’s held by a limited partnership made up of pension funds and other institutional investors. The buy-in is up to $10 million and the lock-up period’s as much as 10 years.

Terms of that duration and nomination normally cuts off access to individual buyers. But that problem’s solved by the fund’s other 15% to 25%. “In order to give access to private clients, who typically have shorter time horizons and need greater liquidity,” Sivarajan explains, “the managers created a liquidity pool that invests in publicly traded REITs and T-bills.”

What that means for you is that the fund can require a shorter, one-year commitment. When you exit the fund, managers convert liquid securities to cash. “I always say, ‘Even though you’re locked in for a year, don’t think of this as a one-year investment.’ [You] have to look at it as a five-year investment.”

Market cycles typically last five to seven years, and it’s safer to be invested for a full cycle. That way, it becomes less important when you get in or out.

Typically, managers must hold at least 75% of the fund in real estate. “That’s important because the purpose of the fund is not to invest in that 15% to 25%. The presence of that liquidity pool is the trade-off [you] have to accept to have easier access to their money.”

The liquidity pool does change the return profile though. It could dampen overall returns, though the liquidity pool could outperform the private property portfolio, notes Sivarajan.

The minimum buy-in for private clients is $1 million, and the allocation against their overall portfolios should be 5% to 10%.

A potential issue is rising operating expenses. “There could also be an extended vacancy rate because of a glut in the market,” says Sivarajan, adding this was a problem in Toronto in the 1990s.

With this investment, you face two main risks. One is illiquidity — the fact you’re locked in. Compared to stocks, the risk here is much higher because you have to give the fund manager one year’s notice before the units will be bought back. Your only other option is to sell on a secondary market.

The other risk is capital loss. Sivarajan says compared to most commercial REITs, private real estate is more stable.