So, let me take a wild stab at your future career goals here:
- You want to make a lot of money…
- And ideally own a building or 3 with your name on them one day.
- And while you wouldn’t mind working the killer hours required in investment banking, you’d like to avoid it if at all possible.
As an added bonus, you don’t even need to go to a top school to get started – as long as you’re good at hustling your way to the top.
And you might even end up with your own island one day, if you play your cards right.
Today we have an interview from a young broker who’s making his way into the brokerage scene – and who can tell you how to do all of the above and more:
The Origins of a Mogul
Q: So what drove you into the commercial real estate world in the first place? Fantasies of multiple skyscrapers with your name on the front?
A: Hah! I think that’s a ways away… but to answer your question, working with real estate was always more interesting to me than say, stocks and bonds. The tangibility of the assets was something that really drove me to the field. It also helped me understand the industry and the processes behind it.
When I was younger, I had some friends who were already in the industry. They were a few years older than me, so I had a chance to see if they were enjoying their career path and making good money. It turned out that they were doing both.
There are some industries out there that employ some really miserable people, but all my friends in real estate seemed like they genuinely enjoyed what they did.
Q: So how did you break in?
A: I started off in brokerage straight out of undergrad. I was doing office leases for a while when I got the buy-side itch. I had been doing brokerage for a few years, and was staring down two paths.
I could continue to do brokerage and see where that took me, or I could go back to business school to make the transition to the buy-side.
I ended up going back to business school, and finding a job with a real estate development firm. After spending a little bit of time there, I realized that what I really wanted to do was own property for myself. And I saw brokerage as the best way to generate enough cash flow to do this.
After a few months of networking, I landed a job at a multi-family brokerage as a sort of apprentice to the established brokers.
Q: Great. And just to clarify for those who aren’t familiar with the field, what exactly do you do as a commercial real estate broker?
A: It’s just like what investment bankers do, but for properties rather than companies.
So they connect buyers and sellers of investment-grade properties, and earn commissions for getting deals done.
Each property is unique and brings a different value to potential investors, so it’s trickier than it sounds to find the right buyer in each sale.
You have the best shot at “making it” in this industry if you have connections and resources and are great at networking and connecting people.
Degrees and Pedigrees
Q: In some industries, like investment banking, having the right pedigree (school, connections, etc.) helps tremendously in breaking in. Did you find that this was the case in commercial real estate?
A: Yes and no. The specific school that you attended doesn’t really matter, especially in brokerage. No one cares what school you went to if they are confident that you can get the deal done.
It’s also generally easy to get your foot in the door in brokerage, at least compared to fields like IB and PE.
The hard part is flourishing once you are in.
Connections, on the other hand, are everything because CRE Brokerage is all about who you know. You can’t get big property deals done unless you have a wide circle of potential buyers, sellers, and financiers.
To that end, going to a top school will generally expose you to more people who could one day be clients/investors/partners.
As a broker, you are constantly chasing new deals. It’s sort of like networking to break into investment banking, but you are gunning for a deal instead of a job offer.
Q: Is there a certain “path” that most real estate big wigs take to get to the top? It seems like a lot of the head honchos are “old money.” How does the “new money” float to the top?
A: There isn’t really one path that real estate gods take to get to the top, but there are common themes. I would say that most people who find great success in real estate have an end goal of owning income properties themselves.
There are actually real estate investors from all walks of life – the key is to find something that you can be initially successful in, so that you are able to generate enough cash flow to own properties yourself.
If you are interested in CRE from the get-go, brokerage makes a lot of sense since it is very lucrative and lets you become involved with the assets themselves. Many successful brokers own investment real estate on the side, and some even transition to full-time investors if they do well enough.
For someone who is interested in CRE as an undergrad, analyst and support positions are definitely the best way to break into the industry. These positions give you a great opportunity to learn about a wide range of real estate transactions.
“Making It”… and Getting Paid for It
Q: You face an uphill battle starting out as a broker. Many burn out before closing their first deal. Why is this?
A: To answer your first question, it’s mainly that it is very easy to get discouraged. There is a ton of uncertainty around when that first paycheck will come in when you are a new broker.
Going back to the analogy of networking into finance, it’s very similar here: you exert a ton of effort and time up-front, with no certain outcome. And as that initial outcome takes months and months to materialize, some people just give up.
This uncertainty, along with the possibility of going broke, pushes many would-be brokers out the door before they even get a fighting chance.
Another big reason for the burnout is the hiring practices of some firms. There are definitely firms out there that do shotgun recruiting, hoping to get as many candidates as possible, and seeing which ones sink or swim. It’s like a scene straight out of Glengarry Glen Ross or Boiler Room, except it’s arguably more ethical.
Companies can afford to do this because there isn’t much overhead in hiring a new broker. While some brokers don’t mind that and just need a desk and a phone to get started, I wanted a little more hand-holding. In that respect, smaller firms are generally the way to go.
The experienced brokers at my office are slowly showing me the ropes while I assist them with their deals. As a younger broker, the most important thing is to have a leader you can look up to while trying to build your business.
Q: So how much can an established broker expect to get paid, and what does the commission structure look like?
A: Everything is on a sliding scale. When the deal is first completed, the broker gets a commission based on the transaction price. This generally starts at ~5% for smaller deals, and the percentage gets lower as the deals get bigger.
Every deal is different though, and there can sometimes be nuances that change the fee structure. Once the broker gets paid, he owes the brokerage firm a cut.
This is on a sliding scale as well, but this time around volume works in the broker’s favor. The percentages differ at each firm, but you can expect to have at least 50% of your commission taken by the firm when you are starting out.
As you start to bring in more deals, you have more leverage and can start taking more and more of your own commission home.
If you are looking for hard numbers, an experienced broker in investment sales (one who has been doing this for a handful of years) should be making $250K at the minimum.
Rock star brokers can make millions of dollars per year, depending on their deal volume and average deal size.
You won’t see brokers who make hundreds of millions or billions of dollars a year, though, unless they actually move over to the investment side and start to buy and sell property for themselves.
Q: Do you have any specifics on what the commission figures might look like?
A: Honestly, I’m not sure of all the numbers because they differ depending on the broker and the deal.
Generally the commission starts at around 6%, but that quickly drops to 4% after the $1 million USD level, and then that scales down to around 0.5% for very large deals (say, over $70 million USD).
When you’re first starting out, you’ll be doing more high commission percentage, but low dollar-value (under $1 million USD) deals and then that will shift in the other direction over time.
Q: Thanks for sharing those figures – it seems like the average pay may be a bit lower than what you see for mid-level bankers, but the “ceiling” is similar, at least at most firms.
How do you analyze real estate deals to make sure the numbers work?
A: Investors generally look at three things when the analyzing a property:
- First, they look at what the building is currently doing – how much income it has been generating and what the property-level expenses are, which gives you the Net Operating Income (NOI).
- Then they look at the property to make sure it can maintain its current income. It’s one thing to have generated strong income in the past, but sometimes factors like mismanagement, demographic shifts, or changes to the local area can drive a property right into the ground.
- Finally, investors project what the building could do in the future to increase income and/or cut expenses.
Depending on what kind of deal it is, investors will focus on either the current income or the projected income. For example, on a stabilized deal that isn’t expected to see much upside, current rents are the key valuation driver.
On a bank-owned REO (real estate-owned) deal, projected income is the driver because often the buildings are vacant and dilapidated.
Q: I see… well, it’s good to know that there’s at least one industry where investors actually care about past performance in addition to future expected performance!
You mentioned “stabilized deal” and “REO deal” – are these the two main deal types you generally encounter?
A: There are four main deal types I encounter:
1) Stabilized deals are the “blue-chip stocks” of real estate investing. These buildings are generally recently built, and currently have a stabilized yield, e.g. 7% or 8% per year.
When investors look at these buildings, they are generally looking to maintain the income that they’re currently producing. There isn’t a lot of risk with a stabilized deal, but also not much reward.
2) The renovation deal is the next type. A property that is a candidate for a renovation deal would be an older building in a nicer submarket (one that can support higher rent prices) that could get significantly higher income or value from renovating the units or the entire building.
There is more risk involved with these deals than a stabilized deal, because investors are banking on the upside of renovating the property, and then reselling it to another investor.
3) Then, there are REOs – basically, bank-owned properties. These usually need a lot of work (the units or the building itself is in bad shape) and are underperforming. Often, these building will have huge vacancies, so the projected income is a big factor in valuation.
REOs carry even more risk than a renovation play because the building needs work AND it is already underperforming.
4) Finally, there are new development deals. These are just what they sound like. Development happens when an investor wants to take the raw land, evaluate what can be built on it, and what kind of return that can generate.
Development deals have the highest risk, but also carry the highest return.
As previous contributors here have pointed out, you don’t necessarily make the most money with development deals, because of the inherent risk and uncertainty – so don’t assume that highest risk = highest bonus in your bank account. It’s not true in private equity, and it’s not true here.
Modeling, Valuation, and Due Diligence
Q: How does the financial modeling process differ in real estate? Are the numbers the primary focus? How detailed does it get?
A: Valuing a property vs. a normal company doesn’t actually differ that much. Whether you are buying real estate, stocks, or bonds as an investment, you are primarily looking at cash flows and returns. In real estate, the property itself will produce the income for your return.
You calculate the cash flow differently in commercial real estate, though – since the building is the “product,” rent is the gross income for the investment. After that, expenses such as landscaping, maintenance, turnover, and management fees are incurred, leaving you with a Net Operating Income (NOI).
That number is essentially the return. Once NOI is established, you can model out many scenarios with different financing to get cash-on-cash returns and do a discounted cash flow analysis.
While the numbers are generally used to support valuation, comparable sale analysis is king when valuing properties. Any investment, whether it’s a stock or a piece of property, it is only worth what someone is willing to pay for it.
With real estate, rather than using a traditional valuation multiple you use the Cap Rate, also known as the Yield in some regions, which is defined as Property NOI / Property Value. So if the NOI is $10 million and the property’s asking price is $100 million, the Cap Rate would be 10.0%.
Q: Thanks for explaining that.
Cap Rates seem to be the primary metric in property valuation. Why is this?
A: Mostly it’s because Cap Rates are a very simple way of calculating the return on a building. Essentially, they tell you what percentage of the funds you paid for the building comes back to you annually.
It’s just an easy metric to use; for example, if you have a 6% cap property, but it’s at a 6% debt interest rate, you can easily see that it isn’t returning any money.
Cap rates do have flaws, however. The biggest one is that everyone assumes cap rates in a specific submarket to apply to every property within that submarket.
And that simply isn’t the case. Every single property has its own nuances that will make it more or less appealing to potential investors. If you get too hung up on the cap rate, you could either be over or undervaluing your building.
You really need to analyze each building and the market thoroughly to get a sense of how much it is truly worth.
Another weakness is that while Cap Rates are fine to use in a region like Manhattan where buildings are constantly being bought and sold, there’s considerably less data in other regions without as many sales taking place, so the numbers may not be reliable.
Q: Thanks for explaining that.
It sounds like you need to do a lot of due diligence for all these property deals – how does due diligence change in the real estate setting compared to what you see for companies?
A: Basically, with due diligence, you are just making sure that the deal doesn’t have more holes than a slice of Swiss cheese. Sellers want to sell their property at the highest price, and brokers have an interest in closing the deal, period.
Buyers have to protect themselves, or they could get the shaft.
Due diligence is generally broken down into two components. You analyze the property in the micro sense, and then again in the macro sense.
In the micro sense, you look at the building itself. You check the market to make sure that projected rent prices at the building actually make sense, and that people are paying those prices at similar buildings in the area.
You might dig deeper and also make sure the tenants are in good financial shape themselves. This is especially true if you are buying a single tenant building, or if you just have larger tenants in general.
For example, if you buy a commercial building with a Starbucks and a Quiznos currently leasing the space, you would want to check the financials of those businesses to make sure they are stable.
Next, you look at macro trends. You look at what other investors are paying for comparable buildings to make sure you aren’t over-paying.
It’s also important to look at macroeconomic trends in the region you are investing in to make sure the submarket can sustain positive economic growth over time.
For example, it would be considerably less risky to buy a building in New York or San Francisco than it would be to purchase the same building in Detroit, even if the price is much lower there.
Q: Great, thanks for explaining all of that. Any final words if you want to become a CRE broker?
A: Becoming a competitive CRE broker is no easy task. It is arguably more difficult to find success than investment banking, because of the ease of entry (lots of hungry young brokers trying to make it big!).
However, those brokers who do succeed can find great wealth, with an outstanding work/life balance, in an interesting and rewarding field.
Q: Awesome, thanks for the interview.
A: Of course! Any time.
Andy Sondag graduated from California State University, Chico, with big dreams of breaking into the financial world. After interning at a small investment bank, he decided to modify his path and ended up as an analyst at a commercial real estate brokerage. In his free time he boxes, rock climbs, and occasionally pretends he is Mark Zuckerberg (he founded Text Spyder, a search engine for college textbook prices).