by Mike Moran, CFA Comments (94)

How to Break Into Commercial Real Estate and Build an Empire

Commercial Real Estate Groups

This is a guest post from Mike Moran, CFA, a portfolio manager at a long-only asset management firm. He started Life on the Buy Side to teach you what it’s like working in asset management, hedge funds, and more.

When it comes to commercial real estate, you’ve got two choices: do something extremely risky, or do something boring and conservative.

OK, you could also pick something middle of the spectrum – but what fun is that?

If you have your sights set on building a real estate empire, you’re going to have to take the leap and embrace the risk with open arms.

Here’s how to do it:

Risk, Reward, and Reality

With commercial real estate, it’s easiest to think of investment opportunities from least risky to most risky and then analyze the players in each category:

Core Investing is all about stability and getting high single-digit returns by operating existing assets. There’s little risk when a building is already operational and generating rental income – think of the GM Building in New York or a class-A regional mall as example investments.

Since these are stable assets that provide a steady income stream to the owners, pension funds are the main investors in core funds – firms that specialize in acquiring and operating existing properties.

You also see Real Estate Investment Trusts (REITs) – both publicly traded REITs and private REITs – in this space, as well as core real estate funds run by real estate investment managers such as AEW and RREEF.

REITs are like private equity firms but for buildings rather than companies – they acquire, operate, (possibly) improve, and then sell properties to earn high returns.

Getting Riskier…

After you leave this Core Investing space, you get into Value-Add and Opportunistic Strategies – this is where the investors try to make substantial improvements and renovations to existing properties rather than just acquiring and operating them.

Returns are typically in the 15 – 20% range, but may go higher depending on how risky the strategy is. Some REITs and core funds managers dabble in this space, but you mostly see private equity shops like Blackstone here – a high single-digit return is horrible for PE, so it makes more sense for them to focus on riskier strategies.

At the riskiest end of the spectrum is real estate development, and the players there are all over the map.

Some REITs have large development pipelines and invest significant resources into constructing new properties – examples are AvalonBay [AVB] (apartments) and Prologis [PLD] (industrial), which often have multi-billion-dollar pipelines.

Private equity can sometimes be active in development, but usually only as the capital partner to developers.

There are also large private companies like Opus that focus on real estate development without the pressures that come from being publicly traded.

Risk = Reward?

Based on the descriptions above, you might think that real estate development offers the highest potential returns and the highest pay since it’s also the riskiest.

But you’d be wrong: It’s a boom-and-bust business, and developers are also the first people to get fired in a downturn.

While Prologis had a $4B development pipeline at the market peak, it dwindled down to less than $500MM after the market collapsed; three of Opus’ five major subsidiaries filed for bankruptcy in the past downturn.

This is not to say that real estate development is “bad” – it’s just that you shouldn’t jump into it expecting to make bank right away.

It’s great if you’re into the brick-and-mortars side of real estate, but if you’re not, think about the other options above.

There are also asset management firms and hedge funds that specialize in real estate securities, and even shops that invest in REITs – if you want to blend real estate and the public markets, both of these can be good options.

How to Break Into Commercial Real Estate

As with everything else in finance, at the entry-level you’re just a high-paid spreadsheet monkey who works on deals all day – whether that’s at the core funds or at private development companies.

A typical “path” for breaking in is to go to a target school and then get into real estate investment banking – that’s what many of the top people at the biggest real estate firms and REITs have done.

Mike Fascitelli, CEO of Vornado [VNO], is an example of a real estate big shot that followed this path. He went to Harvard for his MBA, started at McKinsey, and then went to Goldman as a real estate investment banker. After several years at Goldman, Steve Roth lured Fascitelli away from banking to work at VNO.

But you don’t have to follow that path to break in – and an MBA isn’t even a prerequisite.

The best example is Jonathan Gray, the co-head of Blackstone’s real estate group – Gray started at Blackstone with just an undergraduate degree from Wharton and worked his way up to become co-head of the entire real estate group by age 35. At age 37, he was busy pulling off the $36 billion Equity Office Properties acquisition, the biggest private equity buyout ever (at the time)!

Yes, Wharton is a target school and it also happens to be one of the top undergraduate schools for real estate – but more importantly, it has a great real estate alumni network.

Just like everything else in finance, leveraging your alumni network is essential to breaking in: I wouldn’t be surprised if Gray tapped his network to land his gig at Blackstone right out of school.

Other top undergraduate schools for real estate in the US include UC Berkeley, USC, and Wisconsin – these are well-known institutions, but they’re not the Ivy League and they’re not the ones that immediately come to mind when you think of a “target school.”

Real estate is very much a “who you know” business and having a well-connected alumni base is critical – if you’re at a school without much of a presence in real estate, your next best option is to get an MBA at a school with a strong real estate program.

If you’re already out of school and working, you could get involved in trade groups like ICSC, ULI, or YREP if there’s one in your area.

Whatever you decide to do, networking is even more important in real estate than in other industries so start pounding the pavement as soon as possible.

Got Real Estate Development?

While many top real estate jobs required work experience and/or more than an undergraduate degree, development is one area where undergrads from all different backgrounds can get in right out of school.

So if you’re in this boat and you’re interested in real estate, you’re better off using your career center and alumni network to break in and focusing on development rather than PE, REITs, or anything else.

Q: Do I need investment banking experience to break into development?

A: No, no, and no. In fact, you might have too much experience if you actually do real estate IB and want to break in afterward – an entry-level development role would be a step backward.

Development is significantly different from real estate IB or PE, and they shouldn’t even be in the same category.

Q: Wait, but what should I do with my life if I don’t do investment banking first?! Otherwise everything is meaningless!

A: Pick a major that lends itself to real estate development. Example majors: Real estate, civil engineering, architecture, or construction management.

Since development is much more bricks-and-mortar than other RE-associated industries, knowing these subjects is valuable for breaking in – and you’ll get the alumni network to help you land a development job.

If you don’t know what major and/or school is good for getting into RE development, just ask around and see what types of jobs most graduates get – if “real estate” is a common answer, you’ve found a good match.

Breaking Into REITs

Real Estate Investment Trusts (REITs) are investment vehicles that are exempt from corporate income taxes as long as certain criteria are met; the main one is that REITs must pay out 90% of their taxable income as dividends, which means they have little cash on hand and are constantly issuing debt and equity to fund their operations.

Historically, REITs were passive vehicles that focused on owning properties and escalating rents over time, but today they’re more dynamic, and many REITs buy, sell, develop, and manage properties and 3rd party joint ventures all the time.

A few of the larger REITs in different segments include the Simon Property Group [SPG] (shopping malls), Boston Properties [BXP] (offices), AvalonBay [AVB] (apartments), and Prologis [PLD] (industrial).

Since REITs use so many different investment strategies, there are all sorts of different job opportunities there.

On the operations side are developers, property managers, and acquisition people that deal directly with properties.

On the capital markets side, you’ll find finance people that work on equity and debt deals to fund the REIT’s operations.

If you want to get into the operations side of a REIT, it’s similar to what you need to break into RE development: Get a real estate-related undergraduate degree and network with alumni.

But if you’re interested in capital markets, you need real estate investment banking experience – REITs are one of the main exit opportunities for RE bankers since you advise REITs all the time as a banker.

Bottom-line: if you’re more interested in finance, go the banking route and look for REIT exit opportunities; if you’re more interested in the bricks-and-sticks aspect of real estate, skip banking and go straight into development or acquisitions.

Compensation: What Compensation?

Unfortunately, there are few good data sources on real estate compensation – but pay tends to be commensurate with risk and expected returns, at least in buy-side roles.

The main exception is development – it’s the riskiest investment class and yet the pay is also the worst.

The real money in development accrues to those that put their money at risk in the developments.

To complete construction of a new property, the developer itself only puts down a very small portion of the total equity – maybe 5% or less.

Many times, the developer simply contributes their land basis as the only equity in the project and then uses debt and mezzanine financing to fund the entire construction cost.

Most of the returns will go to the 3rd party investors that come up with the rest of the funds – and to make things even worse, there’s no cash flow from properties that are under development until tenants move in and rental income starts flowing.

Even the fees the developers charge are not great compared to the overhead, so there isn’t much money left to pay salaries to employees.

So, do not get into development if money is your main goal – only do it if you’re interested in building and construction side of real estate.

You will not make it big until you have enough money to invest in development projects yourself.

For core funds and REITs, pay is consistent with base salaries for recent graduates elsewhere in finance – the main difference is that you won’t receive Wall Street-like bonuses in these jobs because the fees and returns are lower than in PE, for example.

On the private equity, hedge fund, and asset management side, compensation is similar to what you would earn at non-real estate funds. So real estate PE is similar to normal PE, real estate HFs are similar to normal HFs, and REIT-focused asset management is similar to normal asset management.

And on the investment banking side, you don’t see much of a difference at the junior levels between real estate banking and other groups.

Exit Opportunities

As with other buy-side jobs, the buy-side itself is the end-game. Once you get there, it’s just a matter of working your way up until you become the next Jonathan Gray.

Be careful of getting pigeonholed: If you get into real estate and don’t like it, move on as quickly as possible or it will become more and more difficult to find a non-real-estate job.

In addition to moving up the ladder, investing in real estate yourself is another possibility: A number of friends have amassed nice little portfolios of multi-family assets.

And unlike buying entire companies, the capital requirements for real estate are far lower and you don’t need to raise hundreds of millions of dollars just to buy a house.

Raising a small fund of your own is also possible, but just as with starting a hedge fund you need to raise some seed money to get started – you would go to friends and family first, show solid performance, and then approach a broader set of investors once you can point to results.

Whither Real Estate?

It’s a great field, but keep your expectations in check.

Until you have enough cash to fund massive real estate developments by yourself, you won’t see your name on any buildings.

And if you want to become as famous as a certain real estate developer – and maybe even become President of the United States as well – it might just be easier to get your own reality TV series instead.

Even More on Real Estate

If you want to learn more about the modeling and valuation side of real estate, check out the BIWS Real Estate Financial Modeling Course, which covers both individual properties and REITs via case studies of an apartment complex, an office development and sale, a hotel acquisition and renovation, and Avalon Bay, a leading apartment REIT.

There are also real estate private equity case studies based on stabilized multifamily, value-added office, and pre-sold condo development deals.

About the Author

Mike Moran, CFA is a Portfolio Manager at a long-only asset management firm. He started Life on the Buy Side to teach you what it’s like working in asset management, hedge funds, and more.

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