The middle market real estate world is an important niche within the industry. It represents a large amount of property across every property type as well as greater diversity than the higher-dollar institutional plays that occupy the segment above it. While still possessing, in general, enough income potential to keep owners’ strategic options wide open. Buy and hold is a valid strategy here, as are shorter-term plays based on significant value add.
It’s these details that make the middle market so interesting. For owners, there is ample room here to be creative with investment decisions and repositioning assets to achieve their highest and best use. For the investment sales brokers that help them identify the right properties, the variety in owners (size and sophistication alike) means that the field is a fertile ground for creative approaches to doing business.
For all its interest, the middle market sometimes attracts less attention than the larger properties favored by institutional investors. This is an unfortunate externality of the nature of the business. Simply put, a $100 million property sale will turn more heads than a $10 million one, and a portfolio of 10 200-unit apartments will attract more interest than a portfolio of 50 6-unit buildings.
Alongside Biproxi, a marketing technology platform built for sales brokerage teams, we wanted to explore the characteristics of the commercial real estate middle market. To do this, we dove into Biproxi’s data and held several interviews with leaders in the middle market brokerage world across a variety of property types. First, we discuss the makeup of the middle market, in terms of overall volume as well as property-specific characteristics. Then, we address the use of tech amongst broker teams to understand where market participants can enhance their operations. Finally, we consider the impacts of the coronavirus outbreak on the middle market.
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Executive Letter
The middle market real estate world is an important niche within our industry and understanding the unique characteristics that make up this segment is vital to uncovering the upside potential. While not as glamourous as the larger properties favored by institutional investors, the middle market is a fertile ground for creative approaches to doing business.
The team at biproxi understands that there are inefficiencies within the middle market that make it challenging for brokers to effectively market their properties and close deals. As such, these were the first pain points the team set out to solve. We built a platform that would support the broker and their business.
As the real estate landscape evolves in response to the current global pandemic, there is a growing need for a digital revolution in the real estate buying and selling process. biproxi currently offers a rich collection of products and services, curated for all brokers. Listing Essentials is a single space for brokers to select and buy what they need on an a la carte basis — think things like 3D floor plans, virtual staging, property photography, etc. Our Marketing Concierge offering is an end-to-end digital marketing solution, created to streamline your selling process and deliver highly engaged buyers, operated by our team of marketing professionals. And most recently we’re proud to bring you biproxiBid, a sophisticated auction process. The online auction platform fills a digital need by providing sellers, investors, and real estate professionals with the tools necessary to conduct business from the comfort and safety of their homes. Especially as market uncertainty grows, auctions offer the perfect solution to deliver a true and current market valuation post-COVID.
Defining the Middle Market
While definitions of the middle market vary, we’re looking, in particular, at properties that occupy the $1-25 million price range, notable for the range of investors that purchase these buildings. According to Biproxi’s data, the middle market represents a vast percentage of total commercial buildings across the country by property count. The middle market includes 83% of multifamily stock, 98% of food and beverage properties, 95% of offices, and 96% of retail properties by property count.
Middle Market Characteristics
With an understanding of the definition of the space we are focusing on, we turn to the characteristics that give the niche its distinctive makeup.
Properties and financing
While these properties represent a huge chunk of the total numeric volume of these different verticals, comparatively few properties carry debt: only 19% of the total middle market stock. Low levels of debt imply that long-term ownership of these properties is the norm, while the 19% of buildings that carry mortgages could represent properties that recently changed hands.
At the same time, the $5-25 million range leaves enough meat on the bones for a variety of creative approaches to adding value. Within the multifamily niche, the type of properties most often in the middle market are class B in quality. According to data from CoStar, these properties have seen lower vacancy rates than class A, and better rent growth than both class A and class C stock. Across all property types, this huge volume of properties as well as the substantial upside they embody means that brokers have a particularly great opportunity to turn significant business in the niche.
Owner profile
Owners for these properties represent a wide mix of investors from small firms or even individual operators up to sophisticated ownership groups and funds. This is largely based on the characteristics that middle market properties tend to display. Institutional money is often less interested in properties under $25 million, leaving more room for everyone else. And these properties can come with a large amount of inherent risk, as well. On the retail side, a lot of middle market deals fall into the single-tenant triple-net space, which are often riskier than multiple-tenant properties, particularly if they lack tenants with strong credit.
“Demographically speaking, buyers of middle-market properties are typically males between the ages of 55 and 75, an age range that has ample opportunity for major life events.”
Jay Rollins, managing principal, JCR Capital
According to Jay Rollins, managing principal of alternative investment manager JCR Capital, “Demographically speaking, buyers of middle-market properties are typically males between the ages of 55 and 75, an age range that has ample opportunity for major life events.” These demographics display characteristics that make properties in this niche particularly attractive to investors. An unexpected marriage, divorce or other life event can instantly change the property ownership calculus, helping fuel opportunity for brokers.
Mr. Rollins also said “Consider this example: A real estate owner in his late 80s passes away and in turn the middle market shopping center that he owned is passed to his daughter, who is a dentist by trade and already is dedicated to family obligations. She may not know anything about real estate or want to deal with managing it. So that property is going to go back into the market, for refinancing or recapitalization or a sale. That will never happen with a major corporate asset or an institutional building. Somebody’s death, divorce or health problem typically does not affect the asset or push it back into the market. But it does in the middle market.”
With that in mind, different owners and buyers have markedly different levels of sophistication. This makes it harder for any broker to sweep in and offer the same exact approach with every client. Some on the smaller side may do things largely by gut, while more advanced apartment syndicators as well as funds devoted to other property types may be more advanced, utilizing comprehensive data sources and modeling tools beyond Excel, like Argus. This also points to one of the reasons why the middle market sees more different types of investors than bigger property segments. Less tenants means easier calculations, and getting trained in proprietary tools like Argus, more common for larger properties, can be time consuming for smaller companies.
According to Michael Fay, principal and managing director for Avison Young’s Miami office as well as chairman of the firm’s capital markets executive committee, the middle market sees a diverse range of private and institutional investors. He added that “We’re seeing a number of private client sponsors with some institutional partners as well. Some of these institutions with a lot of capital are drifting down to this range even if they don’t want to operate it themselves or have the optics that they’re going down to these deals, they’re either lending money or partnering with these private client groups.”
Time on market
The amount of time a given property spends on the market is based in large part on the type of property it is. Multifamily specialist Allan Mendelsberg, principal for Cushman & Wakefield | PICOR, said that “Deals are staying on the market for only a week or two due to the tremendous amount of investor interest we’re seeing.” However, across property types like retail and office, things take longer. Gabriel Silverstein, institutional capital markets chair for SVN and managing director for SVN Angelic, suggested a period of on average 30-60 days from listing to buyer selection. Peter Block, executive vice president for Colliers with a focus on triple-net retail properties, pointed to a 60-day average for property marketing. To some degree, this comes down to the geographic focus of each broker. Mr. Mendelsberg’s market is specifically Tucson, AZ, while Mr. Block, who quoted a much longer marketing period, has a nationwide scope.
Brokerage Tech and Strategies
The brokerage world is experiencing deep disruption due to shifting market needs and growing access to technology across every part of the property transaction. One growing trend could be an increased amount of cross-specialization amongst brokers. Mr. Fay explained that his own personal team has brokers with specializations in different areas, allowing the entire group to serve 100% of a given client’s real estate needs. “For years brokers in the larger markets a lot of the larger brokerage firms were asking their brokers to specialize, for relationship and territorial reasons,” he said. “We’re starting to find that a lot of the private client groups that we deal with don’t mind drifting between, say, office and industrial or industrial and retail. So you have to be versatile in what you’re doing.” For some clients, like institutional groups, Mr. Fay said that principals like to see that their real estate teams possess cross-cutting knowledge that can help them understand how different property types dynamically interact. This kind of expertise can help brokerage teams understand how to uncover new opportunities, like marketing parking lots for conversion into other uses.
When it comes to finding properties to market, the fragmented nature of the middle market make a wide range of approaches and tools relevant. Raw data for brokers often comes from the usual suspects, like CoStar, but there are a number of alternative sources that are applicable, as well. Every brokerage team should consider how much effort they need to spend finding new properties in relation to how frothy the market is at the time. When deals are aplenty, there may be no need to go above and beyond to find new inventory. However, when supply is constrained, it can help to consider a multitude of data sources, and not just rely on one.
Many municipalities have a huge amount of geographical and property ownership data available online, which data-savvy brokers can comb through to uncover off-market properties or ones that may not be captured in purpose-built commercial real estate databases.
For instance, some real estate listing sites and GIS platforms offer the ability to view every property matching certain characteristics within a focus area. Much of this information will be based on whatever official, public data is available on the local city’s assessor’s site or GIS system. However, there is no guarantee that even official city data is accurate or up to date, and even when it is, needing to wait for a commercial database to capture record changes can waste a lot of time. In hot markets with lots of transactions, using data that is even a few months out of date can cause a large amount of wasted effort, as properties quickly changing hands can lead to misplaced prospecting calls and emails. For this reason it can make sense to consult not only a dedicated database but also the underlying raw data as well, as a periodic quality check.
Additionally, some properties are classified in such a way that commercial databases may not capture them. For instance, imagine if a multifamily broker were looking for any complex over 10 units in size. Many databases will allow for a specific search of properties matching that criterion. But imagine a rental property, organized as five duplexes all owned by the same investor. A property like that could fall through the cracks of a database, since it would appear as five separate properties that don’t meet the 10-unit criterion. With this in mind, when supply is low it can be useful to double check both databases and the raw, underlying data, as well as spend focused time on specific neighborhoods or submarkets, to ensure that no deal is missed.
The other side of the broker job, marketing, can benefit from a range of creative, tech-enabled approaches as well. While putting properties on the big listing platforms is a cornerstone of most marketing efforts, there are other ways to expand the buyer pool, as well. Mr. Silverstein explained that social media data mining and advertisements can be used to identify buyers who may not be present on the big commercial real estate listing sites, but may still be interested in acquiring property. At the same time, nascent trends in brokerage, like the use of virtual tour software to show buyers a property without needing to physically be there in person, are helpful for connecting with out-of-state investors. Virtual tours are also an example of a technology that has taken off with the arrival of the coronavirus.
COVID-19 and the Middle Market
Mr. Mendelsberg said that the multifamily market has taken a big hit due to the outbreak, explaining that “A lot of people right now are waiting…we’ve put a few deals under contract with exchange buyers that need to snatch up some property within their identification period, but most of the activity we’re getting is saying ‘wait and see.’ Most of the investors that are coming to us that are new are looking for deep discounts to buy right now and sellers just aren’t there.”
“Most of the investors that are coming to us that are new are looking for deep discounts to buy right now and sellers just aren’t there.”
Allan Mendelsberg, apartments and investment sales principal, Cushman & Wakefield | PICOR
The outbreak is also prompting questions as to which sectors will respond quickest. Retail and hospitality are the property types that have taken the biggest hit from the outbreak but Mr. Block said he expects property types and adaptations made, not geographies, to be the primary determinants of a quick return. He added that “A great example of this is the restaurant space. For fast food, they have really had to focus on pickup and delivery. This has meant infrastructure and technology improvements. ” And for other restaurants, Mr. Block said, another valid solution can be prepared meals which diners can assemble at home.
Another question brokers are currently grappling with due to the virus crisis is understanding how to stay up to date on pricing trends given the transformative nature of the outbreak. According to Mr. Silverstein, “One of the most valuable tools I have when we have a dislocation like a black swan is fellow brokers that I know and trust, like fellow members of SIOR or other SVN offices that I can call on in a given market to get the most up to date information and get a brain trust of a dozen different people to comment on a given product type or region.”
The outbreak has also introduced the element of working from home to the mix. Much of the brokerage role can be done remotely. Marketing, property underwriting and most of the negotiation process pose little challenge, but coordinating property visits and due diligence is harder. Mr. Mendelsberg explained that his team was still going on inspections and other visits when necessary but wearing the appropriate PPE.
The brokerage middle market is an attractive niche for many reasons. It is sizable, relevant to a wide buyer pool, and highly diverse. It allows brokers with different skill sets, whether data, marketing or otherwise, to make an impact and close deals. And it encompasses a huge swathe of properties mixed between offices, retail, multifamily and beyond.
New data shows that COVID-19 has had a big impact on commercial real estate, slashing April 2020 transactions by 71% from the year before. Much like the Great Recession before it, though, the coronavirus will not last forever. Brokerage teams are already establishing new processes and solutions to allow themselves to work effectively while displaced. The value of the middle market as an investment opportunity will live on.
