C&I 2017 Meeting Report: How to Raise Capital in a World of Change?
(for a print version of this report, click here.)
In a world where everyone has a somewhat similar “secret sauce”, how can anyone stand out? Institutional investors have no shortage of advisers and strategies to choose from – in fact, most complain that there isn’t enough time to read all the pitches they get or meet all the capital raisers.
It seems that everyone is a proven real estate investor with a track record of above average returns, everyone has an insightful strategy, and everyone has methodical due diligence and advanced risk management processes. As yields tighten and assets grow scarce, the margin for error is shrinking. Clients are searching for the managers who can give them more, but not necessarily more of the same.
Is Mr. Martin’s advice enough to win the day anymore, or rather should advisers strive to “be so good” in a different way? In December 2017, NAREIM leaders in capital raising and investor relations gathered to explore their changing landscape and to consider a few questions.
Is the ground shifting, or is it just a new generation?
Despite a relatively stable economy in the last year, something seems to be shifting under the surface. Paul Fiorilla of Yardi shared some insights around the pace of multi-family construction, home ownership, as well as the evolving finances of millennial generation, all of which could have meaningful impacts in the months and years to come.
Construction as an industry may be undergoing a systemic shift. Mr. Fiorilla observed, “Whether you point to an increasing shift from a union to a non-union labor force, the lack of younger people going into the construction industry, or the decrease in skilled workers since the recession, construction time and cost has gone up dramatically from 2013 to 2017 – which points to the labor supply going down. At the same time, demand for multi-family rental continues to increase – supply can’t keep up with demand.”
But the highest priced multi-family supply is not where the greatest demand lies. “Rent growth has gotten ahead of itself based on what people can afford. Plenty of people, especially young people, still want to live in these areas; but they’ve just gotten so expensive that even people who make decent money have a hard time affording the rents. So I don’t think we’re going to see much in the way of rent growth over the next couple of years. It’s slowing down and is indicating future negative growth.” Tenants, by necessity are seeking out new markets for investors to follow. Up-town Dallas, Nashville, Denver, and mid-town Atlanta are just a few of the markets that have seen new demand growth, as are neighborhoods and suburbs in proximity to the now over-priced core market CBD’s. No matter how different and exciting millennial renters may be, they still are affected by market forces. They may want walkable environments and close proximity to work and amenities, preferably with some sort of urban “vibe” – but they still have to be able to pay the rent.
…or come up with the money to buy a house. Much of the speculation around millennials today is that as they age, get married, and have children, they will automatically revert to a “normal” behavior of flight to bedroom suburb communities just like their parents. And in recent quarters, some suburbs have seen increasing demand and new migrants from urban cores. However, it is difficult to believe that there will be wholesale migration similar to the second half of the 20th century. Millennials today are making 20% less today than the generation before them at that age while at the same time, the overall percentage of baby-boom generation home ownership is declining.
For these reasons and others, Mr. Fiorilla described himself as “bullish” on the rental market. “Over the last 10 years, we’ve seen the demand in multi-family renters go up from 34 million to 43 million and the number of owned households decrease by 2 million. The average age of people becoming parents has gone up and consumer numbers are down as millennials spend more money on doing things and less money on owning things.” At the same time, there are nearly 20% fewer driver’s licenses among millennials. Far-flung suburban living is difficult without a car, and in walkable neighborhoods, rental housing is often the only economical option.
The opportunity is to find that sweet spot between overpriced core CBD luxury rental and neighborhood or suburban areas with just the right level of affordability and density – or to build it. Waiting for things to return to normal may not be the most reliable option.
How can investment managers work more with family offices?
Historically, commercial real estate was primarily owned by family offices. The relative stability and lengthy timelines of commercial buildings was a good match for investors focused on preserving family wealth and generating cash flow over multiple generations. But in recent decades, institutional and public capital from REITs, pensions, endowments, sovereigns and foundations overtook the market. And yet, there is no reason why family offices shouldn’t continue to be involved, and perhaps even grow their real estate exposure by working more closely with real estate investment managers.
How one works with family offices, however, is a bit different. Christopher Merrill of Harrison Real Estate Capital has worked with family offices over the past 15 years and observed, “It is far more collegial than competitive, very relationship driven, and I found that pleasantly surprising. If you’re working with one family and you’re doing a good job for that family, it tends to open up the entire network of offices.” Plus, according to Mr. Merrill, families look for more disruptive or creative investments with a longer horizon than institutions. “It’s getting more entrepreneurial. I am getting asked by many of them – ‘how can we get more exposure to the market?’”
Michael Scherer of Inland Investment advisors pointed to significant differences in how to approach a family office: “Because there is typically a lack of a real estate professional within a family market fund, it’s important to keep in mind that this isn’t a market you sell to; it’s a market that you teach and build your brand by talking about what you do best. Fortunately, that’s how we built our network, but it took three of four years before we really had our pulse on how family office operates.”
As with any genuine relationship, trust is critical – and trust is most often built over significant time. Tom Handler of Handler Thayer said that, “In a recently published survey of family office capital raisers, I was asked, ‘how long after you’ve been introduced to a potential family office client do you get hired?’ Five plus years! So if you want to work in this market, you must have some staying power.” And yet, according to Mr. Handler, “Dealing with these families is about as good as it gets because they’re looking for a relationship. These families will work to find you – they can find, get to, and afford whoever they want – so aggressively selling or marketing is going to have the exact opposite desired effect.”
Christine Norkaitis of Inland Investment Advisors summed up the approach simply, “It’s all about trust. If they trust you, they’ll do business with you.”
How transparent are we and how transparent should we be?
Calls for greater transparency are increasing. According to Brandon Sedloff of Juniper Square, “There is a very clear trend to sharing more information proactively with investors through two types of managers; those who wait until something breaks and then reacts to fix it and those who want to be head of the curve. It may have seemed like a crazy idea a few years ago, but LP’s are now disqualifying managers who don’t have the right infrastructure in place to handle their reporting and data security requests.” Elizabeth Weiner of Sundial Park Group agreed, “What we see is that what was once considered radical transparency is absolutely here to stay. If you don’t answer investor questions in a forthright way with as much transparency as you can, you do so at your own peril. There is so much competition for capital, and there are plenty more managers ready to take your slot.” And the perspective from the limited partner tends to re-enforce this enthusiasm for clear and concise information when being approached about an investment. Michael Patcock, an investor consultant with Ellwood Associates said that, “If you view the relationship with the investor as a partnership, you can help so much more with their investment analysis. Make your information usable; make it discernible.”
Mr. Patock as well as Chris Lennon of Townsend Associates see organized data and discernible practices as key elements to obtaining investor trust. Mr. Patock said, “If I’m in your shoes considering how I’d present myself to potential investors, I think it’s all about data; that’s the driver for an investor’s decision.” Mr. Lennon added, “It’s not just any data. We invest with a multi-family manager that can tell us in numerical detail what the driver was to any decision against any element of any property. Essentially, it boils down to control on the part of the investor over the investment process; they want more control of the cycle of cash flow as well as more operating involvement regarding how the assets were being identified.”
Data matters more than ever before.
What investors want to hear from capital raisers?
We asked two insightful institutional investors how they assessed investment managers.
Edgar Alvarado of EA Advisory, formerly Group Head of Real Estate Equity at Allstate Investments said that he has “developed a healthy respect for managers who know their limitations in any given market. Investors look for a compelling creation story and pattern recognition of good judgement.”
Drew Ierardi of Exelon Corporation always likes to ask a manager, “What went unexpected right? When people claim that’s not anything that they’ve considered before, I find that pretty revealing. Not everything you’ve ever touched was successful solely because of you.”
To further the discussion, Mr. Alvarado produced a well-thought list of “don’ts” for managers regarding their interactions with investors.
- “Don’t claim proprietary relationships.”
- “ Don’t say that you do off-market deals (I personally don’t believe that they exist in real estate).”
- “Don’t refer to your fees as ‘fair’.”
- “ Don’t say ‘we’re looking to fill out our schedule and we’re wondering if you’re available’.”
- “Don’t come across as if the investor should be ‘grateful’ to be investing with you.”
As instructive and memorable as the negative can be for everyone, they also chatted about the positive – what do they like to see?
Both Mr. Alvarado and Mr. Ierardi agree that managers who aren’t hesitant to ask questions regarding an investor’s strategy will significantly help a manager better understand how their fund(s) may or may not fit. Mr. Ierardi remarked, “The strategies that stand out, are the ones that you don’t see every day.” When assessing managers, “The first thing we look at is bios, track records, and how you describe your market.” Mr. Alvarado added, “My concerns in picking managers are not that different from the challenges that managers face. Indexing is making its way into what has been, historically, an active management market; rising interest rates on fixed income are approaching a tipping point of 4%; and crowd funding presents new competition.”
This is not a time for facile salesmanship, but rather for openness and honesty. As Howard Fields of Inland Institutional Capital pointed out, “Capital raisers can’t overcome bad investor relations; that is the death knell for investors.” Limited and General Partners are part of one ecosystem that today lives under the threat of disruption on many fronts. Change tests everyone. The quality of the partners, and their ability to respond to change as it happens is ultimately the differentiator that matters.← L&C 2017 Meeting Report: Understanding the Rules in a Fast Changing World