You may face a day when the funding needed for your target real estate deal merits an institutional investor. Though this is a sign of success, it can be daunting if you are unfamiliar with raising institutional equity. Real estate investor and longtime pension fund executive Kevin Riordan explains how to begin. As a guest on the Joe Fairless Best Ever Show podcast, he summarizes institutional raising and what entrepreneurs seeking equity can expect.
About Kevin Riordan
Kevin has deep institutional expertise stemming from extensive business and Wall Street experience. He took a commercial mortgage REIT, Crexus Investment Corp., public in 2009 and knows the process firsthand. A full-time professor of real estate at Montclair State University, Kevin grounds his investing in accounting and finance mastery.
Kevin’s career spans 30 years of institutional investing, focusing on raising capital for commercial real estate. As a young CPA, he moved from the accounting group to real estate at work after hands-on experience making transactions. At age 30, he moved to TIAA CREF, a pension fund for educational institutions, and broadened his investment analysis and real estate deals experience. Kevin leveraged 20 years there to create initiatives merging public capital with commercial real estate.
Kevin sees two sides to the business of providing institutional capital for equity. One side is through joint ventures with property developers handling the operations. The other aspect is funding entrepreneurs planning to buy or develop properties.
We Are the Money: The Equity Side
During his tenure at TIAA CREF, Kevin formed many joint ventures with real estate operators. The total project costs ranged from $12 million to $30 million, and the institution would cover up to 100 percent of the funding.
A typical partnership structure has the equity investor receiving a preferred return until reaching a hurdle rate. A hurdle rate is the minimum acceptable rate of return that an investor expects. At this point, the property developer receives a promote, which is an amount above the developer’s contribution. The contract should contain the exact terms agreed to.
Project costs vary with the type of property built. Kevin recalls one apartment building with 210 units in a quaint northern town that cost about $14 million. In contrast, a downtown Atlanta development with some construction challenges ran closer to $29 million.
The project begins with a construction loan to start operations. The institution uses its capital to pay off the loan and shares ownership with the developer. This arrangement grants the institution a preferred return on investment and access to the property’s initial cash flow.
Kevin provides an example of how these transactions typically work. If you put up capital of $1 million at a 6 percent return, your preferred return would be $60,000. The property’s first $60,000 return goes to you, and you and the developer split subsequent gains.
Funding Entrepreneurs: The Buy Side
What if you are a multifamily property investor seeking additional funding and not a real estate developer? Kevin speaks to this situation, too. Many investors start by using their financial resources and then raise funds from friends, family, and professional networks. They may top out and need to raise more capital to pursue their target transaction. Individuals often reach this point when they’ve rolled proceeds from multifamily properties into larger projects and face steeper equity requirements to continue growth.
When institutions invest in these types of projects, the funding is typically in the form of a mortgage instrument that allows the entrepreneur to buy a property or begin development. In return, the investor acquires a coupon or share of the mortgage debt.
If you plan on approaching an institution for capital, you want to present yourself and your business plan in the best possible light. Serious potential investors will conduct due diligence on you as a candidate and on your proposed projects. Kevin shares tips on how to prepare.
Document Your Track Record
A potential investor will first ask you, “What have you done?” The institution’s top concern is that you have a successful track record. Document and quantify your achievements and be prepared to discuss them.
Here are some foundational questions to be ready for:
- Which transactions have you done?
- What was your role in each?
- How did each investment perform?
- How were the deals structured?
- Who were the other partners?
As in a job interview, expect to walk a serious investor through your process on at least one deal.
Create a Detailed Plan
Kevin describes his experience taking Crexus Investment public and meeting with major institutional investors for the first time. He had worked for a large pension fund and was now on the other side, taking his first company public. When visiting Fidelity Investments, BlackRock, and other large players, he found their concerns shared a common thread. In addition to his track record, they wanted to see a detailed and thorough plan.
Kevin stresses that despite differences in scale, multifamily property buyers and institutions must perform similarly to succeed. Nonetheless, the transaction must meet a minimum equity threshold for institutions to consider it. He notes that a $500,000 deal, a hefty commitment for most individuals, is too small for institutions.
Approach Investors at the Right Time
If you are considering institutional equity for your next project, should you approach investors before or after entering a transaction? Kevin suggests working with investors first to secure funding. At this point, they will evaluate you based on your track record and business plan. Ideally, you’re proposing adding one or two zeros to a solidly performing portfolio.
The alternative is to proceed with a deal on a contingency basis. One drawback of this strategy is that you may sacrifice some credibility with partners who prefer to have funding locked first. Another potential issue is not obtaining equity in time or being denied altogether. Lining up institutional financing first is a cleaner strategy.
Prepare for Due Diligence
Let’s assume you have passed an institutional investor’s due diligence, and you have the green light to put together a deal. The institution will draft a profile of your project, and funding is contingent upon meeting the requirements. Your job is to find or develop a suitable property and to check all the associated boxes, as Kevin puts it.
The institution will expect your project to satisfy given criteria such as:
- Property location
- Asset type
- Expected rate of return
- Deal structure
After analyzing the target project in depth, you should be prepared to meet the checklist. However, institutional investors also vet your company’s suitability for executing the project and managing it for the long haul.
Kevin emphasizes that investors assess a company holistically, looking for breadth as well as a compelling investment story. They want to understand how your business’s core people and operations will drive the project’s success. To do this, they look at history as well as current circumstances. For example, did your company triumph over a setback, such as a regional downturn or sudden loss?
Kevin suggests preparing for an evaluation of your past and present operations and any principals besides yourself.
Areas of scrutiny include:
- Accounting systems
- Operating agreement or articles of incorporation
- Other company principals
- Financial history
- Response to adverse conditions
- Plan for operating the new property
How to Find Institutional Investors
Suppose you have your CV, company, and investment plan in place but have no institutional contacts. How do you reach out to these large equity investors?
Kevin suggests you partner with an intermediary such as a real estate consultant or mortgage broker. Many of these professionals arrange equity as well as debt and can facilitate the right introductions. When contacting mortgage brokers, for example, ask whether they work with institutional equity.
You and the institution will benefit from an intermediary’s services. Institutions prefer this approach because it weeds out the deluge of nonstarters and helps identify quality prospects. As an entrepreneur new to the process, you will gain valuable guidance from a high-caliber consultant or broker.
Make Your Bold Move
What is Kevin’s best advice for real estate investors new to institutional equity? Paradoxically, it is to act boldly while sensibly mitigating risk.
Kevin refers to a personal lesson learned. Following the Great Recession, he could have purchased $2 billion of Barclays Bank mortgage debt. Instead, Kevin bought only $750 million and left a significant profit on the table. He attributes the decision to caution over boldness.
If you haven’t already, you will eventually encounter a deal that seems like a fortune-changer. You will probably need to move quickly and irrevocably. According to Kevin, the key is to balance bold action with a clear understanding of the risks in a given investment opportunity. These decisions are always challenging, but isn’t that the fun?