The success of private equity real estate over the last decade has been impressive. So much so that real estate-related investment opportunities are becoming more of a focus for traditional stock and bond investors and traders as they seek avenues for diversification. Despite the real estate market inevitably entering a downturn, a recent survey conducted by Deloitte shows that 97% of investors intend to increase their investment in real estate over the next 18 months despite that flattening yield curve. Accessibility to opportunities and decreasing barriers to entry are also playing a key role in this influx (e.g. crowdfunding for commercial real estate). Increasing availability of capital is never a bad thing for commercial real estate sponsors. But how they handle the demand for better equity arrangements and increased transparency is sometimes key to winning a share of these incoming investor dollars.
Continue reading to learn some of the ways that increasing sophistication of the commercial real estate investor is impacting the way sponsors operate their businesses.
General partner (GP) / limited partner (LP) joint ventures are inherently simple. The foundation of a GP LP deal is that the GP brings the industry knowledge and expertise while the LP provides a majority of the equity. Profits as they relate to capital contributions are shared disproportionality due to the human capital and “sweat equity” the GPs provide – GPs do most if not all of the work, and that is reflected in their profits. However, there is the rare occurrence when an LP can outearn a GP.
Co-investment is when a sponsor does want to or isn’t able put as much skin in the game as needed to meet a standard that investors deem as a meaningful amount of equity. Typically, a deal will consist of a 10% to 90% GP/LP structure, where a GP supplies 10% of the cash, and the LP provides 90%. The LPs want the GPs to feel as if they have a consequential equity stake in the project. Sometimes 10% is too high of an amount to take off their business balance sheet. In this case, LPs will allow GPs to put in what they deem to be a meaningful investment and source the remaining capital from elsewhere. This additional capital co-investment capital could be subject to a different set of agreed upon terms, often times more favorable, than other LP’s involved in the deal.
Today’s investor is not quite as trusting as they were a decade or two ago, and the pool of available investors is different than it used to be. Some investors still have the recession fresh in their minds, so they aren’t as trusting with their capital as they once were. Others have seen increased transparency with other investing opportunities and want that same experience in CRE. And some are Millennials who are accustomed to the latest and greatest technology and expect a user experience that is digital and instant. Further, the modern investor is becoming savvier due to the amount of data and information available at their fingertips. In order to secure new capital in the market, a modern investing experience predicated on transparency will be crucial.
According to Deloitte’s 2019 Commercial Real Estate Outlook, “More than 80% of the survey sample believes that CRE companies should prioritize the use of predictive analytics and business intelligence. In fact, over the next 18 months, nearly 2/5 plan to increase the use of these two technologies to make their investment decisions.” This is good news for investors who want to see data analysis that communicates why a deal is such a great opportunity. In addition, the need for trust and transparency is growing. Investors want real-time updates on investment performance without needing to call or email the GP. If CRE sponsors and owners can provide their investors with the modern investing experience that is expected, they will create a competitive advantage for themselves in the marketplace. The status quo is changing in real estate, and for an industry that is notorious for slow technology adoption, it is happening quickly.
Commercial real estate technology will drive greater efficiencies for your firm, improve analytics and data accuracy, streamline the business, and ultimately drive the bottom line. But deploying new technology isn’t always easy. Download the free checklist to learn how to create a strong business case for CRE technology!