STRENGTH IN NETWORKS
The Next World-Class Opportunity Is Closer Than You Think
The world is full of opportunities; you just need to know where to look and what connections to make. That’s where we come in. In commercial real estate, I still see brand- new opportunities from sources I’ve been working with for 20-plus years, and there’s a reason for that. These are opportunities and deals sourced by world-class operators and family offices. These are people who have been operating for generations. They know precisely what they are doing. Real estate is in their DNA. At any given time, a family office has at least $100 million in assets under management (AUM). These families are patient, passive investors who know what they want, and they will make decisions quickly when the right opportunity presents itself.
Members of the family office are at the top of their game and have solid backgrounds in investment and money management. They’re genuinely world-class, and they want to maintain this status. They are tightknit and form business relationships on pedigree; if something is out of place, a deal will not happen. These families are also interested in deals not available to the masses. This, too, is a belief of mine: The more widely an investment is made available to the masses, the less desirable and more speculative it becomes. Our firm operates with this belief in mind as we work with family offices. We operate in a space not many investors have access to. I’m talking about those opportunities not available to the masses. How do we source these kinds of deals? It circles back to the network we’ve built up over the decades. You cannot underestimate the power of a strong network. I’ve said this in the past: People who have failed at making investments in the past (whether those investments are venture capital, private equity, or real estate) had to learn the hard way that it’s the strength of your network that provides the most value to you as an investor.
deal, from our real estate deals to private equity investments, gets a background check. We don’t want to waste your time or money. When you bring this all together, you are left with an impressive deal flow, often paired with favorable terms. You get the benefits of our established network as you invest alongside these family offices. You also get their networks. That’s more capital and more relationships, which means more opportunity for growth. But more than that, there’s mitigated risk. I believe in the conservative approach. It’s not about playing high risk/high reward. You want to know that your investment is protected. My own portfolio looks something like this: 15 percent venture capital and private equity, 50 percent real estate, and the remaining 35 percent in equities, physical gold, and cash. Should the markets crash in the next 24 hours (they won’t), real estate income is protected and insured, while venture capital and private equity investments don’t usually correlate with publicly traded markets. These companies are illiquid. The conservative approach often requires patience, but many of the family offices appreciate working with other patient investors. And many of the companies we vet are interested in money from patient investors who have been successful as entrepreneurs. They want to work with people who have seen the world and know what they want. This is who we work with: people who know what they want and are in search of that next world-class opportunity.
Networks aren’t just about finding opportunities or a flow of deals. They are crucial when it comes to performing due diligence on these entities. It’s risk
management 101. And we do that due diligence. By the time a deal reaches any of our clients, it’s been thoroughly vetted. Every single
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There are two schools of thought on this very sensitive issue.
THE CORRELATION CAMP
The cap rates are correlated to the interest rates and must rise simultaneously. As interest rates increase, cap rates will also increase, and real estate values will traditionally decline. If this camp is correct, we will see a destruction of equity investments made over the last three to five years, since much of this exit underwriting was heavily weighted on stable exit cap rates. It will only take a 100–150 basis point move to turn a great investment into an equity impairment. The cap rates are not correlated to the interest rates. Cap rates are based on capital flows, confidence, and the historical spread between cap rates and risk-free rates (which are still high). Interest rates can increase, cap rates will not change, and real estate values will not be affected. If this camp is correct, we will see a continued bull run in real estate values and equity investors will be handsomely rewarded. THE NON-CORRELATION CAMP Our partners have chosen to embrace the view that interest rates and cap rates are, technically, correlated . In response, we are employing an upside hedge approach. We are underwriting to higher base case cap rates and working to see our investors’ principal protected through an 8 percent cap rate and beyond. Thanks to this approach, we will not be hurt if cap rates increase and will do better than projected if they do not. WHAT’S THE VERDICT?
HARD QUESTIONS YOU MUST ASK BEFORE INVESTING IN COMMERCIAL PARTNERSHIP DEALS
PART 1
Real estate has always been regarded as an equal opportunity wealth creator. However, caveat emptor (buyer beware), because real estate also can be full of scams. This is the No. 1 reason why smaller investors don’t invest, and the last reason why all real estate deals fail.
Here are a few essential questions to help cleverly identify the strategic risks and rewards associated with any real estate related investment.
HOWMUCH IS THE OPERATOR, THE PERSON MANAGING THE DEAL, INVESTING PERSONALLY?
When somebody comes to you promoting an investment opportunity, ask, “How much are the prospective fund managers investing personally?” If they don’t have a stake in the deal and things go wrong, they are likely to walk away from it.
IS THERE A HUGE UPFRONT FEE OR LOAD?
When you ask this question, the response you get will reveal the sophistication of the operator you are dealing with. Fees should be considered imagined, not a load or anything upfront in which they immediately take 10 percent off the top of your investment. If they are looking to take fees right off the top of your $1000 investment now, you are left with a $900 investment. That’s a bad deal.
WHAT IS THE EXIT STRATEGY?
Do not invest in a real estate fund that presents no clear-cut exit strategies for its investors. There are only two ways investors can get taken out of any commercial real estate deal: refinance or sell. Make sure you are getting on board with an investment group that is either capable of successfully closing a sale or qualified to get the property refinanced and get its investors out. Many potential real estate investors buy based on emotion, often fearing that they’ll miss out on a great deal. But you should never let fear drive you to make a snap decision. Do yourself a favor. Take a moment to ask these vital questions before jumping into a bad deal.
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TROUBLE ON THE HOR I ZON The Comi ng D i l emma Ove r R i s i ng I n te res t and Cap Ra tes
Reflecting on economic and real estate conditions from 2018 and developments in the industry in 2019, two major factors stand out.
1. Cap rates have been low for a long time, vacillating between 4.5–5.5 percent in many markets. The effective federal funds rate stands at 2.4 percent, and the 10-year treasury stands at just over 2.6 percent. In a recent interview, Jamie Dimon, the CEO of JPMorgan Chase, commented that he would not be surprised to see the 10-year rate at 5 percent. 2. The Federal Reserve made three rate increases in 2018, bringing the federal funds rate to 2.5 percent. Many expect two to three additional increases in 2019, bringing the rate to 3.0–3.25 percent. Faced with these circumstances, the real estate industry needs to ask one simple question: Are cap rates correlated to interest rates, or will the rising interest rates cause cap rates to increase as well and cause a decline in real estate values?
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