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!
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
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.
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.
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.
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:
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.
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.