Where should real estate investors put their cash?

Experts weigh in on how to get the best returns -- for newbies, mega-developers and everyone in between

As the Dow Jones Industrial Average nears record-setting territory, would-be real estate investors may be tempted to embrace traditional stocks and bonds instead.

But in many ways, New York City real estate is still a more desirable play, according to financial advisers, academics and brokers.

Sure, some apartments are still selling below their mid-2000s highs, but where full buildings are concerned, prices have increased.

The average sales price for multi-family apartment buildings in Manhattan was $502 a square foot in 2012’s fourth quarter, up from $462 at the end of 2008, according to data from commercial brokerage Eastern Consolidated.

Manhattan land, hotels and retail condos have seen similar price gains. And the market for office-building sales — excluding trophy properties — has roared back, especially in 2012’s last quarter.

Meanwhile, capitalization (or “cap”) rates — which measure return on investment — have dropped to around 4 percent, down from 7.5 percent during the depths of the recession. Analysts said that drop shows that investors are now willing to pay more for New York City properties than they were when the economy was struggling.

Investors are bullish on New York because of some promising macroeconomic factors: Not only has the city’s population been rising, which has led to a housing shortage, but the hiring rate has increased sharply in the last year compared to other metropolitan areas.

In a city where some homes now trade for $10,000 per square foot, real estate plays may seem inaccessible for small-time investors. But analysts pointed to smaller investment opportunities, like buying in an up-and-coming area in the outer boroughs or purchasing a “piece” of a building.

This month, The Real Deal asked analysts where real estate investors at all levels — from newbies to veteran developers — should place their bets for the best returns.

For investors who have: $100,000

As obvious as it may seem, $100,000 doesn’t buy a lot in New York — at least when it comes to real estate.

Yet experts identified three areas where investors with that much cash to spend could get the best returns: outer-borough co-ops and condos; building syndication deals; and stock for publicly traded real estate investment trusts, or REITs.

In the first case, the money might be used to secure a mortgage on a $400,000 one-bedroom in one of Brooklyn’s many up-and-coming neighborhoods.

Prospect Lefferts Gardens is one emerging area that could see residential values quadruple in the next decade, if one assumes the increases similarly marginal areas, like Dumbo, have experienced in the last 10 years, said David Kramer, a principal at the Hudson Companies, which is building an $80 million, 254-unit rental project on Flatbush Avenue in Prospect Lefferts.

“My advice for friends who get anxious about buying into strong markets,” he said, “is to invest in transitional neighborhoods.”

Marco Lala, an associate broker at commercial firm Marcus & Millichap, said that $100,000 could go even farther if pooled with other investors’ money in a so-called syndication deal.

While usually smaller in scale, syndication deals are similar to the Empire State Building purchase in 1961, when thousands of investors pooled together cash. And if the investment is led by an experienced real estate player, these deals also usually don’t require investors to get involved in running the buildings, he added.

Syndication is a good option for people who want to invest in real estate but “don’t want to manage properties [and] collect rent,” Lala said.

What will they get for parting with their money?

If the money is invested in an office building in busy Midtown filled with high-credit tenants, investors can expect returns of 5 or 6 percent, Lala estimated. But syndication investments in prime Midtown are few and far between.

Taking a chance with a syndication investment in a multi-family building in an up-and-coming neighborhood, on the other hand, is riskier, but could yield returns of 12 to 15 percent a year, he said. And the buy-in amount can be as low as $30,000.

Syndication deals are often organized through word-of-mouth and through so-called “private placement brokers” who act as intermediaries between smaller and larger investors.

Meanwhile, the barriers to entry are also low for investing in REITs, which are trading at about 9 percent above the underlying value of their real estate, said Paul Adornato, a REIT analyst at BMO Capital Markets, a New York–based financial-services provider.

Shares of some private REITs are also available, but buying them requires an intermediary at an investment bank. Other private REITs, though — like American Realty Capital, Cole Real Estate Investment and Inland Real Estate Group — are more accessible to individual investors, sources said. Together, these types of private REITs have raised tens of billions in capital in the last few years, analysts said.

And in March, the mega-investment firm the Carlyle Group also made it easier for mom-and-pops to get in the game by sharply lowering its previous investment minimum from around $5 million to $50,000. But some analysts caution that the fees associated with those investments could sap many gains.

Andy Gerringer, a managing director at the new development firm the Marketing Directors, said REITs are a good option for investors at this level. In the last decade, he pointed out, REITS have generated about 12 percent returns. That’s better than the 4 or 5 percent that many Manhattan buildings yield these days.

Andy Gerringer

Gerringer, who has personally dabbled in REIT investing, said self-storage REITs are particularly hot right now.

“The more people move into small apartments, the more they need storage,” he said, adding that self-storage companies have “very low maintenance costs.”

And self-storage REITs were trading at a 36 percent premium last month.

Another plus for small-time investors is that REITs are relatively liquid, meaning investors can get in and out quickly, unlike other types of real estate assets, said Lawrence Longua, an associate professor specializing in capital markets at the New York University’s Schack Institute of Real Estate.

For investors who have: $1 million

Again, $1 million doesn’t mean what it used to.

“A million dollars might not get you more than a parking [spot] in Manhattan,” joked Eric Anton, a managing partner at Brookfield Financial.

But industry experts identified several smart investments that could yield respectable returns at that price.

One option is buying a modest Manhattan resale apartment. Anton said he would steer clear of investing in ultra-luxury residential properties in chic Manhattan areas, where new-construction, one-bedroom condos can sell for more than $2,000 per square foot. That doesn’t provide an investment much room to grow, he said.

Instead, he and others recommended that investors who are looking for a residential property target something older, then improve it to unlock its value.

Armed with $3 million in purchasing power — assuming a $2 million mortgage — an investor could pick up a four-bedroom unit at, say, 860 United Nations Plaza, an undervalued postwar co-op, said Donna Olshan, founder of residential brokerage Olshan Realty. The apartment could be worth around $5 million in just a few years, with a renovation, she said. “The formula has always been, you buy the thing that needs the most work in a prime building or neighborhood, and you win,” she added.

For a longer-term play, she prefers the Garment District in the West 30s. While it may be more difficult to get a loan there, Olshan predicted the area would increase in value substantially as the nearby Hudson Yards mega-project gains steam. Some estimated that a buyer who gets in now could end up seeing their investment grow 7 to 10 times over, eventually.

Brooklyn offers tempting opportunities, too. Adam Hess of the Brooklyn-focused commercial firm Terra CRG suggested leveraging that $1 million into $3 million with a loan, and buying a small rental building in a popular area of Brooklyn, like Carroll Gardens or Park Slope.

This “super-safe investment” could generate annual returns of 5 percent, assuming monthly rents of $2,000 to $2,500, he said. He added, however, that paying a management company to oversee the building would eat into that profit.

A riskier investment would be in an up-and-coming area like Crown Heights; a bank might not approve a loan here, so an investor might only have his $1 million in equity to play with. But $1 million can buy a four-unit rental building there, Hess estimated. That building might fetch $1,773 a month for its one-bedrooms, based on data from brokerage MNS.

“You’re just starting to see the restaurants coming there,” Hess said. “You want to get in before all the restaurants.” A 6 or 7 percent return isn’t unrealistic in Crown Heights, though, because the area has a ways to go before being fully gentrified.

Those hoping to strike it rich with outer-borough rental buildings may be disappointed, however.

If you were to generate $180,000 in annual rental income, that profit would evaporate quickly, said Arik Lifshitz, chief executive of DSA Realty Services, a Manhattan-based brokerage. That’s because the debt on the $2 million loan works out to $110,000 a year based on current interest rates of 3.5 percent.

While a $70,000 profit may seem like a lot, Lifshitz said it should be socked away to cover capital repairs, like a broken boiler or flood damage in the wake of a storm like Hurricane Sandy.

For high-net-worth investors, another option is to park $1 million with a private equity firm specializing in real estate, whose minimums for investment are usually in that ballpark. Examples include the Blackstone Group, a major real estate investor, and Savanna Partners, which both invest in and operate real estate.

Those types of private equity firms may split that contribution up among several buildings, diversifying the investment and hedging risk, analysts explained. If invested properly, in well-managed buildings without debt loads, that money could yield returns of more than 10 percent, brokers said.

The firms will also charge a management fee of around 1 percent of the equity,plus another 20 percent of the profit after the investor makes their money back. And investors might need to stick it out for a while; these types of investments often require commitments of three, five or seven years.

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For investors who have: $10 million

For those with $10 million to spend, experts said that private equity and distressed asset funds are a smart way to go.

Indeed, a slew of developers and institutional investors have spearheaded these types of funds in the last few years to pool together financing for new projects and property purchases.

For example, the Related Companies last year completed fundraising for an $825 million distressed equity fund designed to purchase the debt on struggling residential and office properties both in New York and elsewhere.

According to published reports, returns of 20 percent are expected over the seven-year life of the distressed fund. If those returns are realized, a $10 million investment would grow to $12 million.

Other companies with funds include Blackstone, which raised a $6 billion fund last year, Vornado Realty Trust, the CIM Group and Savanna.

An investment of $5 million to $10 million is generally the price of admission to this exclusive club, said Dan Fasulo, managing director at research firm Real Capital Analytics.

For investors who want to play a more active role, TerraCRG’s Hess said a smart play right now would be to invest in several multi-family buildings. He said $10 million in cash could buy, for example, five rental buildings in an emerging neighborhood on the eastern side of Prospect Park.

“If your play is to buy a building and utilize its upside,” or turn apartments over to install higher-paying tenants, “you’re better off spreading it around a bit,” he said.

Of course, because tenants sometimes stay for decades, putting all your eggs in one building’s basket can be risky, he explained.

Another option would be to leverage the $10 million into a $20 million loan and buy a six-story low-rise office building in a more desirable Manhattan neighborhood like Gramercy, Lifshitz said. Investors who aren’t interested in running a building and finding tenants can hire a seasoned management company to do this for them.

And there’s always a luxury Manhattan apartment, but the high-end market in condos like 15 Central Park West or One57 appears to have topped out, with little room for short-term improvement, brokers said.

For investors who have: $100 million

In nearly all cases, those with $100 million to spend are not your casual investors. They are savvy real estate players — such as sovereign wealth funds, private equity firms and pension funds — on the hunt for core assets.

And their options are relatively wide open, at least on the multi-family property front, which experts say is a solid investment, considering how consistently the city’s population has been growing and how tight the housing market is.

Paul Massey

Plus, banks are generously opening their purse strings to these sorts of investments, brokers said, lending money at rates as low as 2.5 percent for what they consider relatively safe plays.

An investor who leverages $100 million into a $300 million loan can invest in a rental portfolio with as many as 30 properties, said Paul Massey, founding partner of commercial firm Massey Knakal Realty Services.

Those types of buildings are the mid-block, walk-up variety, with between 20 and 30 units, that dot the city from the East Village to the Upper East Side.

But the money won’t flow in hand over fist; these are conservative cap rates of 4 percent. In fact, the most lucrative investment of this type in Manhattan likely offers a cap rate of just 5.5 percent, though that could rise as rents climb.

“There is a natural roll,” Massey said, “as people move, as people get older.”

But a desirable development play right now could be erecting a rental tower in Midtown East, perhaps on Second Avenue, where one-bedrooms with high-end finishes can fetch some $3,000 a month, said Steven Kohn, president of Cushman & Wakefield Sonnenblick Goldman, the debt and equity financing division at Cushman & Wakefield.

That price assumes a development price of about $800 a square foot, which factors in everything from land costs to marketing fees, Kohn explained, adding that “rentals have been much more financeable” lately.

But condo financing has not been impossible. And condos can be a good target for the $100 million investor, who can leverage the amount to $300 million.

As a rule of thumb, luxury condos make financial sense if they can sell for $1,500 a square foot or more, said Howard Michaels, CEO of the Carlton Group, a private equity firm.

The way the math works? The developer buys land for $500 a foot, and spends another $500 a foot to build, say, a 50-story, 100,000-square-foot condo with high-end finishes. If he can sell the units for $1,500 a foot, he can make $500 a square foot on the project, or about a 50 percent return.

Of course, between approvals and construction timelines, condo developers should expect it to take several years to get their money back, he explained. And sources noted, they are more exposed to the whims of the market than developers who opt for rentals.

Some investors may even be able to leverage $100 million into $1 billion in loans.

That happened just last month, when developer Joseph Chetrit paid $1.1 billion to buy the 53-story Sony Building on Madison Avenue, which he plans to convert to luxury condos, a hotel and high-end retail shops. With the help of SL Green Realty — which pulled together $925 million in financing — Chetrit was able to buy the building with a mere $100 million down payment. SL Green kicked in some of that financing, but the Bank of China provided the bulk of it and a Middle Eastern sovereign wealth fund provided a crucial line of credit.

In general, oversees investors, including sovereign wealth funds, tend to like lower-risk “core” investments, brokers said.

Pension funds tend to distribute their money more diversely, with 7 to 10 percent returns expected, Michaels said. For instance, TIAA-CREF, which manages about $500 billion in retirement savings for teachers and others, shelled out $190 million in 2010 for 685 Third Avenue, an empty 31-story office building on East 43rd Street. The lobby was renovated, and the building was leased to tech tenants like Salesforce.com. Then in 2011, TIAA-CREF sold a 50 percent stake in the building for $100 million.

Last year, TIAA-CREF picked up a 49 percent stake in New York by Gehry, the luxury rental at 8 Spruce Street, for $250 million. Most of its funds have generated returns of up to 7 percent.

For investors who have: $1 billion

Of course, there are only a handful of developers and investment funds that can play at the $1 billion level. Experts say the best bets in this league are portfolios of high-profile office buildings or multi-family buildings, or developing über-luxury condos like One57. Choosing which one of those options is best, of course, depends on how much risk and reward an investor is looking for.

Consider Norway’s massive oil-backed, $680 billion sovereign fund, which recently began pumping money into New York.

Last month, the fund bought its first U.S. properties, including a pair of office buildings in the city: 470 Park Avenue South, which includes two 17-story towers, and 475 Fifth Avenue, a 280,000-square-foot building across from the New York Public Library. (The $1.2 billion deal was for majority stakes in five buildings, including those two.)

Those kinds of centrally located properties can net an annual income of $500,000 each — a 5 percent cap rate right out of the gate, according to NYU’s Longua. In a few years, with the right tenant moves, the building could return 9 percent annually, or $900,000. While those returns might not be off the charts, they are reliable, analysts said.

A riskier but potentially more profitable option right now for a player with $1 billion, experts said, is developing high-end condos in a sought-after area of Manhattan. Extell’s One57, the 90-story high-rise on West 57th Street just a few blocks from Central Park, is a good example of that. The tower reportedly cost $1.5 billion to construct, but penthouses are reportedly selling for near $10,000 a square foot.

Of course, industry observers noted, access to prime development sites in the city is extremely rare and often takes decades of assembling adjacent plots of land. And condo development comes with inherent risks. For starters, the developer has to sell out in a short time frame to get a desirable return, Longua explained.

For every extra month that the “meter is running” and carrying costs mount, the developer will see his margins shrink.

“No sophisticated investor is going to take this on until he sees double-digit numbers,” Longua said.

Still, industry insiders noted that luxury residential projects are the easiest way for investors to recoup their money relatively quickly — assuming the market holds up.

For example, if all goes according to plan and a condo sells all its units in 18 months for its targeted price per square foot, the investor can walk away with a return of 15 percent or more.

At the under-construction One57 — where sales are ongoing — Longua said 60 percent of the construction financing is probably borrowed money, which means Barnett will need to pocket at least 15 percent of the other 40 percent, or about $90 million, to call the project a success.

While that fat sum may be attainable, the market can turn in a heartbeat, Longua said, adding that real estate cycles are getting shorter and more volatile. “I tell my students to go to dental school,” he joked.

Others suggested spreading around the $1 billion in several different investments.

Several sources said a smart strategy for investors with $1 billion is to buy distressed loans and then foreclose on them to get the underlying real estate. But those investments tend to be “spread around the country,” said Marcus & Millichap’s Lala.

Nationally, $1 billion could buy a 300-building, multi-family portfolio with returns as high as 10 percent, given that housing markets aren’t as strong in other cities.

And in Manhattan, there doesn’t seem to be a bad neighborhood. “There’s almost nothing on the island now that isn’t worth looking at,” Lala said.