Welcome to the world of retail investing, a sector teeming with opportunities and untapped potential. There is a vast array of topics and information to explore and dynamic individuals to connect with. Before you can dive in, however, you need to understand some essential vocabulary about the kinds of companies that will be joining you on your adventure.
One phrase you will hear most often in the industry is “vertical integration.” If this phrase is foreign to you and you feel baffled when investment firms describe themselves as vertically integrated, don’t worry. You are not alone in this confusion.
Mastering the concept of vertical integration is crucial for any savvy retail real estate investor or hopeful partner. Vertical integration has the potential to significantly enhance your investment and significantly influence how firms operate.
In this article, we'll break down what vertical integration means for you as a retail investor and how you can use it to your advantage in your new investment journey.
Ready to learn? Let's dive in!
What is Vertical Integration?
Vertical integration, simply put, refers to a company controlling many of its business processes from start to finish.
We can think about it within the retail real estate industry: When an investment company is vertically integrated, it controls all components of its investment process independently instead of bringing in outside consultants to assist.
Vertically integrated real estate investment companies handle every part of the investment process, including things like
- Finding and buying key properties
- Managing tenants and their leases
- Maintaining the property
- Handling related construction projects
- Selling the property
Vertically integrated firms can maintain complete control over each step of their processes. This allows these firms to employ practices that save money and increase value for investors.
Why is Vertical Integration Important in Real Estate?
Managing a retail real estate investment requires high coordination and skill. Companies must handle multiple challenging processes, from negotiating property deals and overseeing renovations to ensuring that properties are continuously well-leased and maintained. How well or poorly these processes are managed can significantly impact the investment's success.
By making most services internal, retail investing companies can operate more smoothly and reduce costs for their investors.
Since vertically integrated companies do not rely heavily on outside contractors, they can react swiftly to unforeseen problems through internal channels. This makes vertically integrated retail real estate companies more stable and predictable than those who are not.
Downsides of Vertical Integration
Of course, no strategy is perfect, and vertical integration has weaknesses as well as the strengths that we have already highlighted—primarily the qualifications and skills of a property manager at a vertically integrated company.
The independent consultant is sometimes better suited to managing a specific property than the in-house sponsor. Additionally, vertical integration can lead to a lack of innovation and diversity in management practices, as the company may become too focused on its internal processes.
For example, imagine if a vertically integrated company acquired a 300-unit apartment building and established a property management company to oversee it. The problem is that the company has never managed a property larger than 40 units.
It would be more beneficial for the investors if they hired a third-party firm with experience managing multiple 300+ unit properties. This is especially true since, generally, the cost is the same either way.
Key Services Offered by a Vertically Integrated Real Estate Firm
- Leasing Services: A vertically integrated firm’s leasing team can better utilize relationships with retailers to fill properties quickly. Maintaining high occupancy levels can ensure investors receive a steady income stream, particularly in competitive markets where speed is vital in securing quality tenants.
- Property Management: Daily management is vital in maintaining a property’s value and retaining satisfied tenants. A company that internally supervises its properties can align its management with the company’s investment plan, improving the efficiency of operations, better tenant retention, and higher returns for investors.
- Development: Often, vertically integrated companies have in-house development experts who add value to the management process, particularly when properties require construction or renovations. By internally managing projects, a company can better control components critical to maximizing property value, like costs, timelines, and quality.
- Construction Management: Enhancing existing properties usually requires specialized construction management personnel. Vertically integrated companies with their construction teams can ensure that renovations are done on time and within budget, further boosting their properties’ value.
- Marketing: A knowledgeable in-house marketing team creates strategies tailored to each property’s needs, leading to increased foot traffic and tenant sales. Keeping a company’s marketing efforts in-house ensures that all branding efforts for properties align with the company’s investment strategy.
Evaluating The Benefits of Vertical Integration for Investors
While vertical integration provides several benefits, like increased control and cost savings, there are better choices for some companies or investors. A vertically integrated company's long-term success depends on how well it manages its internal processes.
If a company streamlines all aspects of vertical integration, it can make the investment process smoother and more efficient, resulting in a higher possibility of greater returns.
The comprehensive approach of vertical integration can provide investors with a solid sense of security and additional reassurance about the potential success of their investment.
When choosing an investment company, investors should carefully examine the capabilities of a vertically integrated company by analyzing its track record, talking with past and current investors, and visiting properties that the company manages. A company with notable strength on all three fronts will more likely deliver consistent and reliable returns.
Additionally, it's important to evaluate the company's vertical integration strategy. Look for signs of effective cost management, streamlined operations, and a strong focus on investor returns.
Of course, there are questions beyond vertical integration that an investor should ask about a company before deciding to work with them. Below are some topics that can give you a strong foundation for conducting due diligence on an investment company:
- How long has the firm been in business?
- What is the founder's experience level?
- What is the experience level of the management team?
- What kind of culture does the company have?
While these are just a few to consider, many more questions will likely naturally come to mind during your interactions with the firms as a potential investor. Additionally, once you begin researching a specific company, you will be able to brainstorm unique questions that are unique to them.
Having a place to start is always the most important step.
Conclusion: Utilizing Your Knowledge of Vertical Integration
Vertical integration in retail real estate can be a powerful framework that, when utilized correctly, can increase the value of investments and improve process efficiency. By managing all elements of the investment process internally, firms can exercise more control, reduce costs, and provide higher returns.
However, a vertically integrated company needs to be successful with skilled personnel to partner with them and be a beneficial option for investors.
When considering a vertically integrated firm, an investor should first determine whether partnering with this kind of firm is the right choice for them and, secondly, whether a specific firm has the resources and expertise to manage investments effectively. Ultimately, the success of a vertically integrated company is key when choosing whether to use a firm that utilizes this strategy.
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