How to Attract Institutional Capital
By: Kelvin Tetz, partner, and Greg Martin, partner and national real estate practice leader, Moss Adams LLP
Local and regional developers who want to build relationships with institutional investors will need to implement these reporting and operating guidelines.
MANY REAL ESTATE owners, operators and developers seeking long-term growth are interested in institutional relationships, but building such relationships can seem daunting. Investment partners with billions of dollars to invest rightly need proven and capable partners. How does a local or regional real estate firm get into the institutional-investment club? The key is to get one’s existing house in order, so that investors who court these local or regional partners can more easily understand and embrace the real estate firm’s strategy.
While every firm has its own development strategy, one key to leveraging that success to attract institutional attention is to implement the reporting methods that institutions need their partners to use. Examples of internal components for local and regional operators to consider include 1) building an institutional-quality reporting system; 2) having a proper understanding of key issues, such as U.S. generally accepted accounting practices (GAAP), fair-value reporting and international financial reporting standards; and 3) creating operating guidelines that articulate the operator’s practices.
Institutional-quality reporting requires a higher level of transparency and quality; it often also requires more frequency. Investors now want to see a combination of strong internal controls and ease of retrieving financial reports and information so they can feel comfortable and safe doing business with the operator. Becoming “more institutional” isn’t easy. Is it worth the effort? And are investors still seeking regional opportunities?
Why Institutional-Partner Funding?
The growth trajectories of local and regional real estate firms are often limited by their funding and finance capabilities. A firm finding success in increasingly larger real estate projects may discover that it is even more challenging to fund big projects. Institutions, however, have the opposite challenge: Their overall capital deployments often require sizeable investments of at least $50 million or $100 million as a starting point and can be difficult to align with appropriately scaled real estate partners.
But institutions are looking. The Hodes Weill & Associates and Cornell Baker Program in Real Estate’s “2016 Institutional Real Estate Allocations Monitor” showed a continued demand for real estate investment but a lack of appropriate opportunities. “Real estate is trending toward a 10%+ institutional portfolio allocation, [however] institutions remain broadly under-invested relative to target allocations,” the report said. It also found that, in the area of private investment, “Larger institutions continue to show strong interest for non-fund vehicles including direct investing, joint ventures and separate accounts.”
One Operator’s Institutional Ties
Regional operators take different roads to success but reflect similar aspects in modeling themselves to be attractive to pension fund, private equity and other institutional sources. One particularly successful regional operator, Blake|Griggs Properties, has a portfolio of projects in development totaling more than $750 million in the San Francisco Bay Area. Its leaders told the San Jose Business Journal in October 2016, “We’ve demonstrated a good track record and institutions find that attractive. The team we’ve put together is very capable and high quality. Lastly, our projects both in terms of location, size and quality are of institutional caliber.”
Added principal Brad Blake, “We serve as a bridge for institutions with large sums investing wisely. Finding regional experts is really important for them.”
The institutional world clearly adds more complexity for smaller or midsize companies. Many regional firms historically produced financial information that was reviewed, compiled or internally prepared using tax-basis accounting or some other non-GAAP basis of accounting. Institutional investors are likely to want U.S. GAAP-basis, audited financial statements, including fair value reporting of some or all of the firm’s real estate investments.
Some operators already are using fair value reporting as an internal tool, but even these accounts need to be audited when institutional partners are involved. Institutions may require quarterly rather than annual reporting, as well as periodic internal valuations, external appraisals or both. For these reasons, the high reporting bar set by National Council of Real Estate Investment Fiduciaries and Pension Real Estate Association (NCREIF PREA) Reporting Standards — formerly known as Real Estate Information Standards, or REIS — is becoming increasingly common among real estate businesses that engage in a number of joint ventures or funds with institutional investors.
Fair value reporting for real estate companies encompasses multiple formats, creating a good deal of diversity in the market. Getting it right requires choosing the correct adviser and independent auditor.
Similarly, operating guidelines provide an important tool for firms working with institutional investors that may require better information, especially as it relates to a higher level of reporting, including fair value reporting.
Operating guidelines are a basic building block of success for any real estate company, particularly for an early-stage firm aiming to be a registered investment adviser or even the next Blackstone. Once you have chosen the reporting standards and approaches you plan to use, it’s important to codify them in your operating guidelines.
These guidelines might include the following elements:
1) A statement of objective or overview with process points for various actions. A system should be put in place that details how each process, such as accounting and check writing, is handled, to make clear that there are checks and balances in place. This statement can also serve as a guide for staff changes or other potential disruptions.
2) Business plans for the company and for key business lines.
3) Quarterly or midyear forecasting.
4) Asset management reporting practices.
5) Disposition or acquisition processes, including steps for solicited and unsolicited transactions.
6) Valuation processes for properties and investments, especially if you are operating under fair value reporting.
Codified practices and guidelines also come into play in the following situations:
A New Fund. A real estate fund manager has been successful for many years in opportunistic real estate with friends and family and wants to expand into a new line of business: a core investment fund. Detailed operating guidelines will help this fund manager better attract more institutional-level capital and effectively explain, in detail, how the new team brought in to execute the new strategy succeeded in carrying on the corporate culture of the existing firm. Detailed operating guidelines help define the bench strength of systems, procedures and execution.
Calming Investors. Even well-established operating companies may need to develop operating guidelines or new policies and procedures because of changing industry and client needs. Codifying and documenting procedures offer transparency and public company-style reporting that are increasingly the norm. They can also calm investors by helping them better understand the underlying operations.
Real estate developers and operators can find obtaining institutional funding to be a daunting objective, but taking a long-term view and building toward that goal can be a smart strategy. The effort can also provide insights into operational improvements that could pay off for the firm with or without an institutional partner. These best-practice approaches can yield significant benefits, either way.