In the best of economic conditions, raising equity can be a daunting challenge for smaller real estate operators, but especially for members of historically under-represented communities (sometimes referred as “emerging managers”). Now, as the economy faces significant macro headwinds, and large institutions like endowments and pensions are reducing their CRE allocations, questions abound as to how that will impact the availability of LP capital as these smaller investors identify new opportunities in the market. A panel of capital allocators shared their perspectives at the REEC 2023 Spring Conference.
Panel moderator Jennifer Taylor, CEO of Ambiculture Advisors, first sought clarity around what type of transactions institutional investors are seeking in the current market. Multifamily and industrial assets seemed perennial in favor assets, with muted interest in ground up development, given current exposure and the high costs of capital for new projects.
However, BMO Financial Group’s Carl Jenkins pointed out that the drivers for institutional investors are often highly nuanced. He explained “We invest for the Community Reinvestment Act objectives of the bank. For most banks, 90% of their CRA investment needs are through LIHTC (Low Income Housing Tax Credits). We are probably closer to 50%. We invest primarily in commingled funds, but will fund direct on a periodic, select basis.”
MCB’s David Bramble also illustrated the point that there is danger is over-generalizing investor sentiment. “We’re really doing a little bit of everything. We think that a lot of times people wipe out entire categories because they are not in vogue or too hard to get through their investment committees. We find ourselves running towards those things sometimes. We just closed on a distressed office loan last week. But we will do naturally occurring affordable, market rate, love industrial and love retail.”
When Taylor probed how the capital allocators decide which operators to invest in, each pointed to the importance of competence, resilience, and sound judgment. “We want managers that have established track records and are performing in the first or second quartile,” said Amit Aggarwal of the Los Angeles County Retirement Association (LACRA). For Jenkins, it boiled down to prior performance and people. “At the end of the day, can you count on that manager to work through the tough times?” He also included more practical considerations. “For a bank the opportunity for other business whether it be debt, cash management, wealth management are important. We look for managers where we can have a broad relationship with besides being an investor.” Starwood’s Bakari Adams added, “We want smart and talented people because they make good decisions. If you have the experience in-house and you want to go do it (spin-off) on your own, we will invest in you, but you have to show that you have the experience.”
In other rooms such a comment may been taken for granted but for many at the conference it gave fresh cause for optimism. A recent NYTimes article pointed out less that out of 112,000 development firms nationwide, only 1,000 are black or Latino owned. Lack of access to capital has been a major reason why. Adams elaborated. “There are over 1500 real estate firms in the country. 4.6% of these firms are women and people of color. If you break that down further, it represents 2.7% of assets under management. And then, break it down even further, 0.5% of real estate fundraising has gone to people that look like you. So how do we change that? If we had more capital, imagine how many opportunities we could create.” Starwood’s impact vertical, Starwood Impact Investors, not only invests as a LP on commercial transactions, but takes a minority stake in real estate companies owned by diverse sponsors, providing critical operating capital like overhead and pursuit fees to help them grow. While the minimum LP investment is $25 million, investments in operating platforms can be substantially smaller. “If a sponsor is used to doing $5 to $10 million deals,” Adams explained, “we will invest in that company if they have the ability to scale.”
For years, institutional investors like pension funds have had allocations for “emerging managers.” But the term can be misleading and confusing, as it can connote both diversity and size, with thresholds that are often too high for smaller entities to qualify for. The variety of definitions was highlighted when Taylor asked each panelist to define what actually defines a emerging manager. For Aggarwal, it was a minority-owned firm with less than $300 million of AUM. For Jenkins, it was investment managers on their first or second fund. Bramble, it depended on who one was talking to at the time and could apply to firms with as much as $2billion in AUM. It was clear from such dialogue why raising institutional capital has historically been a process too dauting for most.
That’s why institutional allocations devoted to earlier-stage operators are proving so timely. Like Starwood, Bramble’s MCB can go beyond a passive LP interest. Funded by a separate account with global asset manager GCM Grosvenor, Bramble invests in diverse operators that are talented, but too small to traditionally attract institutional interest. Bramble explained. “We pitched GCM that there is an opportunity to help sponsors that aren’t quite ready to do a deal directly with a large platform or they are ready and missing a piece of capital like the GP commitment, which can be big dollars. Especially for folks that are spinning out and getting started and looking at someone saying this is great I’ll give you $25 million but you need to show up with $5 million bucks.” Bramble made it clear though that capital wasn’t the only advantage of the program. In addition to capital, MCB provides operational support to help their operators build the processes and infrastructure necessary to attract institutional capital down the road. Additionally, the depth of Grosvenor’s investor base, ranging from pension funds to life insurance companies, not only strengthens sponsor credibility but offers visibility to future sources of capital.
While the prospect of having access to Co-GP capital is powerful, Taylor asked the question still burning on the minds of many attendees in the room. “ To start a fund or not start a fund?” Bramble shared his point of view. “What people don’t understand about funds, you hear people talk about them like the holy grail, is that it is really really hard. It you go to any of GCM conferences, you see that chart where you don’t make any money until like fund four. And it’s true. I’ve seen it 1000 times. It’s not that the deals aren’t great. It just takes so long to get all your capital invested, to cover all the costs associated with starting a fund, to carry the platform, so I tell people who are starting out unless you have a very rich uncle who is going to write you a huge check to get you started you are way better building track record deal by deal.”
In closing, Bramble offered final insights around raising capital. “The secret is there are so many people that will give you money for a good deal. You have to really know what you are doing, the confidence to approach people, and if it’s a good deal you will be able to find money. It will take you so long to raise a fund that if you just did it deal by deal you could probably get $200-$300 million of deals done in a very short period of time. And then, once you have established yourself you will have a track record to take to an institutional investor.”
Despite the continuing uncertainty in real estate markets, the panel offered tangible, practical direction for emerging managers looking to deepen their access to capital and signaled what could potentially represent a new inflection point on the range of equity funding options for smaller operators.
Written by Vernon Beckford at [email protected]