A Primer on Institutional Equity Capital
There are many institutional equity funds that individually manage hundreds of millions of dollars and collectively manage tens of billions of dollars. Their sole purpose is to invest in equity partnerships with local real estate professionals. Understanding the genesis of these funds and their objectives will shed light on ways in which real estate developers may utilize these funds in implementing their strategic plans.
Investment through the 80’s
Real Estate equity capital was traditionally raised through several sources—private equity, life insurance companies, pension funds, and savings & loans. The private sources were what they remain today—nice to find but likely limited in capacity compared with its institutional brethren. Life company and direct pension fund capital was, and is, bureaucratic by nature. Attaining this capital was beneficial to developers but usually required a lengthy and tedious funding process. Many developers also financed their projects through savings and loan institutions. Thanks mostly to then current tax laws, many projects were funded based on depreciation tax benefits rather than economic fundamentals. All was well in the commercial real estate world but for the impending doom of recession and tax reform.
A New World
The 1986 Tax Reform Act essentially eliminated the depreciation tax benefits that spurred so much development. By the close of the 80’s, the country began to enter a recession. A significant volume of real estate loans became insolvent jeopardizing many financial institutions’ regulatory standing. To address the situation, Congress formed the Resolution Trust Corporation (RTC) to oversee these troubled institutions and restructure or liquidate their loan portfolios.
This was an interesting turning point in commercial real estate’s financing fundamentals. Until this time, real estate investment was a foreign concept to most Wall Street professionals. However, Wall Street recognized the opportunity to buy loan portfolios for pennies on the dollar, restructure or foreclose the loans, add value to and stabilize the underlying assets, and exit by profitably selling the investments. These first “opportunity funds” forged the path for restructuring the real estate capital markets. Investment banks began issuing new real estate loans that were subsequently securitized and sold to investors on the secondary market.
The Next Step
In a seemingly natural progression, many investment banks and the new opportunity funds began forming discretionary real estate equity funds in the mid-90’s. These entrepreneurial professionals raised equity capital from pension funds, endowments, and high-net worth individuals. Unlike traditional pension funds and life companies, the managers of these new funds were, and continue to be, characterized by entrepreneurial traits. Most developers will recognize and identify with these characteristics—transaction driven, decisive, and opportunistic.
Profiling the Funds
No two funds or investment programs are alike. However, most funds have some underlying fundamentals in common that should be of interest to developers. The most important point to understand is that investors in any specific fund expect certain minimum returns. These returns are determined by a combination of market dynamics and a particular fund’s investment purpose. For instance, a pension fund may allocate more or less money to real estate depending on its investment alternatives such as stocks or bonds. Another example is perhaps economic conditions favor funds that invest in multi-family rather than class A office space.
Such concerns are strategically considered by fund promoters when raising a fund. Whatever factors and threshold returns exist, the point to appreciate is that funds and their managers only make significant money once the promised returns are achieved. This inherently makes fund managers entrepreneurs rather than bureaucrats. Investment decisions are made at the fund level and require no approval from their investors. This accomplishes several things that developers may find germane to their objectives. First, the funds’ discretionary nature translates to greater efficiency compared to other institutional capital. Second, fund managers have great flexibility in structuring transactions once minimum returns are achieved.
Discretionary institutional equity funds have grown in size and stature through the years. While the funds continue to adapt to the competitive environment in which they operate, they are certain to remain an integral component of commercial real estate finance. Real estate developers and investors with the client profile described in this website should seriously consider an institutional equity partner to help meet their strategic objectives.
Through its long-standing relationships with institutional equity funds, Mayer Capital Partners understands the investment world described above. If a long term capital partner fits your strategic plan, let us assist you in the process. Review our senior management and transaction history. Contact a Mayer Capital partner to discuss your specific situation. We will be pleased to discuss our capabilities relative to your needs. We look forward to hearing from you. All inquires will be held in strictest confidence.