Neville Isaacson's initial foray into commercial real estate investing in the early 1980s nearly marked his last. An immigrant from South Africa, Isaacson used his $25,000 of equity capital to develop condominiums in the Los Angeles area with three other partners. But when interest rates ballooned to 23% and shut down the home-buying market, he bailed out and eventually redirected his investment strategy at rental housing.

Some 25 years later, Isaacson owns a $100 million portfolio of Class-B multifamily assets primarily in the Southeast, a region that has enjoyed steady population and employment growth over the long term despite currently experiencing hiccups on both fronts. He entered the Southeast after selling most of his Southern California assets at the top of the market a few years ago. He'd like to start buying again in the Golden State, which is where he accelerated his property acquisitions during the real estate crash of the 1990s.

The problem is that prices haven't dropped to levels where Isaacson thinks they should be despite the downward pressure that the frozen credit market and economic slump have put on property values. Still, he predicts, the slipping prices are close to igniting a new cycle of value creation, the main reason Isaacson chose property investing shortly after he moved to the U.S. roughly 30 years ago.

“I did a survey of other businesses and saw that real estate was where the value was long-term and decided it was the best thing for me to do in this country,” says Isaacson. He now counts his son and daughter as partners to help source deals and manage roughly 2,000 units largely located in Georgia, South Carolina and Alabama. “But right now, I'm just sitting on the sidelines,” he adds.

Investor evolution

Isaacson is one of tens of thousands of individuals known as high-net-worth investors in the U.S. who have put their dollars into commercial real estate to build wealth, diversify investment portfolios and fund retirement. Historically, real estate experts have defined high-net-worth investors as small owners who typically acquire non-institutional assets for less than $20 million.

But that definition has morphed over the last decade to include super-rich individuals, syndications, operators who partner with private equity funds, families and others. Harvey Green, president and CEO of the Encino, Calif.-based Marcus & Millichap Real Estate Investment Services, for example, includes investors with as little as $500,000 in equity to as much as hundreds of millions of dollars in equity by his definition.

“We see all kinds of people across the board using real estate to build wealth,” says Green, whose firm has built its 38-year-old business almost exclusively in the high-net-worth arena. “There are people who do it as professionals, and there are professionals in other fields that get involved in real estate.”

Regardless of their size, many high-net-worth investors like Isaacson continue to hunt for deals. More often than not, however, the would-be buyers are cooling their heels due to what they consider lofty and unrealistic expectations by sellers.

The number of property transactions of between $5 million and $20 million during the first eight months of 2008 fell 45% from the same period in 2007, according to New York-based Real Capital Analytics. Meanwhile, dollar volume retreated 52% during the first eight months of this year versus the first eight months last year.

Daniel Altman, an apartment investor who owns some 7,000 units in New Jersey, Pennsylvania and Delaware with various partners, says that prices have yet to drop in and around Philadelphia. “And the debt markets are much tougher than they were a year ago,” he adds.

Critical mass

Still, the small high-net-worth market propels the vast majority of all commercial real estate investment transactions. Despite the dramatic drop in activity and dollar volume, 92% of all sales were below $20 million in the first seven months of 2008 compared with 84% over the same period in 2007, according to Marcus & Millichap, which brokered $20.7 billion in investment sales last year.

The size of the high-net-worth market and the activity among such investors continues to spark competition among brokerages. Grubb & Ellis Realty Investors, the investment management subsidiary of Santa Ana., Calif.-based Grubb & Ellis Co., early this year launched a wealth management division to serve high-net-worth individuals and corporations that possess at least $15 million in equity.

The definition of high-net-worth individuals and how to service them may be expanding, but many of the investors still pursue a tried-and-true strategy: building portfolios of well-located but tired multifamily or multi-tenant retail properties that offer upside opportunity.

An initial cash-on-cash return of 5% or less, for example, can swell to 20% or 30% in a few years, Isaacson says. As investors grow older, they frequently dispose of management-intensive assets and plow the proceeds into passive investments like triple-net-leased retail buildings.

Yet high-net-worth investors like Daniel Altman are happy to hold onto apartments for the long term and refinance the properties to return equity to partners. In addition to sponsoring several apartment ownership groups, Altman is a principal of Altman Management Co. in suburban Philadelphia, a firm that manages about 14,000 units — 7,000 of his own and 7,000 as a third-party service provider.

Altman's father began investing in apartments soon after he returned from World War II, and the younger Altman along with two of his siblings and another partner have carried on the business since the early 1990s. Following the popular high-net-worth blueprint to add value to multifamily assets, Altman typically searches for mismanaged or undercapitalized properties in Class-A or Class-B locations and repositions them.

While Altman and his partners shoot for properties of between 150 units to 200 units, they're willing to take on bigger and riskier projects. In fact, late last year they bought a 970-unit complex in Blackwood, N.J., for $52,000 per unit. Tenants occupied 80% of the project, but drug problems and other social maladies plagued the asset. Altman reduced occupancy to 65%.

“We cleaned that job out,” he says. “We knew going in that it was going to be a three-year turnaround period, and we budgeted about $1 million in rent loss.”

Pent-up demand

High-net-worth investors continue to hunt for properties and execute the value-add strategy, particularly in reaction to the stock market's plunge. As of mid-September, the Dow Jones Industrial Average index had fallen more than 17% year-to-date. As a result, wealthy buyers want to put more money into real estate to escape the equity market's uncertainty and volatility, Green says.

Traditionally, other volatile times provided real estate investors with opportunities to buy assets cheaply, add value and profit from appreciation as the real estate cycle improved, experts say. But the petrified capital markets have thrown would-be buyers and sellers into a standoff.

Investors don't want to pay prices that sellers want for fear of continued economic erosion and the inability to price risk, experts say. On the other side of the equation, owners are toughing it out in this cycle. Unless they are highly motivated to sell, many owners refuse to accept offers that are generally lower than they would have been two years ago, says Dan Martin, a managing director with the national retail team of Irvine, Calif.-based Sperry Van Ness.

“This is the kind of market where a lot of my clients made their mark by remaining smart and aggressively looking for deals,” says Martin, who is located in the Arlington Heights, Ill., office of Sperry Van Ness. “But a lot of buyers are running into a financing market that, quite frankly, they've never seen before.”

Liquidity challenges

While debt terms vary by property type, location and asset quality in addition to a borrower's history, the capital markets are causing novice real estate investors the most trouble, experts say. Generally, real estate investors just starting out need greater leverage to beef up returns. But in some cases lenders today are demanding fledgling borrowers contribute equity equal to 50% of an asset's cost compared with an equity requirement of 20% to 25% some 18 months ago.

Experienced high-net-worth investors also aren't immune. In today's volatile lending market, they're required to put up 35% to 40% in equity to cover the cost of an acquisition. Capital providers also are demanding that borrowers personally guarantee at least some of the loan, a provision known as recourse financing.

“There are still financing options available, but not as many as a year ago,” says Chad Brue, senior managing director of the private client group for Los Angeles-based CB Richard Ellis, which generally focuses on investment sales of between $1 million and $20 million. “A year ago our debt and equity finance brokers would take a deal out and get 15 quotes. Today they're getting four or five.”

Joe Gose is a Kansas City-based writer.

See also: Grubb & Ellis ramps up wealth-management shop.