As you’re researching real estate investment firms, there’s one question you might want to ask each company, a question most investors overlook: Is your business vertically integrated?
When it comes to investing in multifamily real estate, a vertically integrated operation can offer investors many advantages, some of which we’ll explain below. First, though, let’s briefly discuss what we mean by vertical integration.
Vertical integration describes a company that controls more than one stage of production of a good or service, and sometimes the entire production. For example, an agricultural corporation that grows food, processes that food, and then sells it at the corporation’s own retail grocery stores, would be an example of a vertically integrated company.
Now let’s think of this in terms of commercial real estate. Most businesses focus on addressing just a single aspect of this asset class. Some firms in the commercial real estate industry simply raise capital to acquire properties. Then there are private lenders, loaning money to real estate developers or investors looking to rehab existing properties. There are also property management companies, construction firms, real estate sales organizations, etc.
A vertically integrated real estate investment company, then, is an organization set up to handle many or even all of these aspects of a commercial real estate investment. In the case of a multifamily property—a 100-unit apartment complex, for example—a vertically integrated real estate company could handle all of the following operations under the same corporate umbrella:
As you can see, a vertically integrated real estate company is typically comprised of several business units. These units all operate as distinct entities, developing expertise in their respective domains, but they also work closely together to serve the interests of the broader business—and its investors.
Let’s discuss that more deeply now. What benefits can a vertically integrated real estate business offer its investors that other real estate firms cannot?
There are many advantages of vertical integration when it comes to real estate investing, so we’ll discuss just a few of the more significant benefits here.
A vertically integrated real estate investment firm can generate an unmatched level of domain expertise and understanding of both real estate best practices and the market in general that other companies simply cannot.
A company that simply acquires commercial properties, holds them in its portfolio, and outsources to third-party experts all of the other aspects of the business—property management, financing, maintenance work, rehab, construction—will likely gain expertise in the process of identifying and acquiring viable investment properties. This is fine for its investors.
But if that same company also had in-house expertise in property management, demolition and construction, consider how much more money it could be saving and generating for its investors.
This is one reason a vertically integrated platform can often be the way to organize a real estate investment company to maximize its’ return for investors.
Imagine this scenario: A commercial real estate investment firm identifies a potentially viable property at an attractive price, but that property will require significant rehab and rebuilding to bring it up to rent-worthy condition. (Let’s assume this is why the price is so attractive.)
If this hypothetical real estate investment firm were not vertically integrated—if they simply acquire properties and outsource their management to third parties—then they would need to have a construction company and plan in place before making the purchase. If they didn’t have such a firm ready to begin work immediately, or at least not a firm in which they had complete confidence, this deal would probably not be viable for that investment company.
But a vertically integrated company would have its own construction and development unit operating under the same corporate family. Moreover, that construction unit’s interests would be aligned directly with the interests of the acquisitions team, the property management team, and the firm’s other divisions: to generate the greatest returns possible for the company’s investors.
What this means is that a vertically integrated company is uniquely positioned to make more deals work than other real estate firms that aren’t vertically integrated.
Finally, a major advantage of vertical integration in real estate investing is that is can create economies of scale—the proportionate cost advantages a business enjoys when it increases its level of output.
Consider a vertically integrated real estate company specializing in multifamily properties in a specific geographical region. Such a company will develop deep expertise across all aspects of such properties in that area—their market values, the most cost-effective ways to build or upgrade such properties, as well as the best ways to manage them, find and screen new tenants, add value to the properties, etc.
When a vertically integrated company such as this concentrates its focus on a specific category of property—such as multifamily—and further concentrates this focus by limiting its acquisitions to a specific metropolitan area, with time that company will develop a set of processes that allow it to invest more skillfully and efficiently. The proportionate costs of these investments will fall as the company acquires more properties and learns from each of these purchases.
In other words, a vertically integrated real estate investment company—and its investors—can benefit from the economies of scale the company is able to develop through its growing portfolio and narrowed focus.
If you’d like to learn more about a multifamily real estate fund that leverages vertical integration to deliver its investors all of these benefits we’ve discussed, and more, let us introduce you to The Worcester Fund from Worcester Investments, the trusted name in Kansas City multifamily real estate.