Strategic Commercial Real Estate Partnerships
www.arrivatollc.com – Being that we are within the Ultra-High Net Worth and Family Office Environments as practitioners, our consulting entity and myself personally are contacted on a regular basis by operators and developers in the commercial real estate community.
These operators and developers are often seeking a capital partner for their next project or future projects. On the other side of the table, we are fortunate to belong within a few very key Ultra-High Net Worth and Family Office circles. These private families and their family offices are often looking to identify relationships with talented operators and developers in regional markets that they can become a co-General Partner or Limited Partner in their direct transactions. A number of these family-backed funds have been practitioners in the very type of transactions they are now seeking partnerships within.
These Ultra-High Net Worth entities would like to deploy a large amount of capital into the marketplace and there are no shortage of transactions being pitched by operators. However only a small percentage of partnership ever come together.
The challenge always remains “alignment of interests” among both parties.
A typical Ultra-High Net Worth Family or Family Office considers over 100 proposals on a yearly basis and makes less than five (5) investments. Most of these scenarios are sub-institutional in terms of size since this is the range most transactions are completed within the market and there is a significant need for capital deployment below the institutional level.
With this being said, there are usually two types of operators/developers we hear from – the entities accustomed to working with formal private equity or institutional style capital and those who have primarily raised capital on their own from friends, family, the country club route, or other high net worth investors through traditional capital raising activities. The former are usually the most natural to work with since they are accustomed to typical processes and structures with other Ultra-High Net Worth investors. Usually, it is a matter of aligning personalities and philosophies with this group.
The latter group is usually the most challenging at the onset. These are usually groups that have controlled the structure of their transactions and offer nominal returns that are better than what the typical investor receives from their retirement accounts. While this capital comes at a lower cost, it also is very time consuming to raise and many operators/developers are experiencing this capital drying up – especially as their pipelines scale. And the time consuming aspects are not limited to raising capital, but also having to stay in communication with several of their investors throughout the course of the endeavor.
On the other hand, these developers are very intrigued by establishing a relationship with an Ultra-High Net Worth Family or Family Office. This is usually more of a sophisticated relationship with one formal investor who is much more of a strategic partner than several friends and family investors, yet friendlier capital than those from hedge funds. This capital also allows operators to scale their portfolio more aggressively with a deeper pocketed investment partner.
The challenge generally is alignment of interest with terms and structure. While operators usually provide their friends and family investors with nominal returns and straight distribution splits in their own favor, the structures with an Ultra-High Net Worth partner is much different. The cost of capital is higher return models, waterfall structures, and distribution splits that are aligned with the percentage of exposure of capital the family is taking in comparison to the operator/developer. As an example, if the operator/developer is contributing 10-20% of the equity and the private family is contributing 80-90% of the equity participation, the private family is going to seek a majority portion of the upside in the earlier stages of the project while those distribution splits being scaled back as operators/developers achieve specific performance hurdles. As a result, there is usually an adjustment period in methodology on the part of the operator/developer. Once they work past this mental adjustment, the operator/developer usually begins embracing the opportunity to develop a relationship with an Ultra-High Net Worth Investor.
We have worked with two such entities in recent months. One of these entities has a very strong track record as a value-add operator for nearly 20 years. He has developed a strong reputation for turning around under-performing assets. He generally contributes 10% of his own cash towards the equity participation while raising the rest of the capital on his own through calling on country club investors. As his pipeline is growing with the strengthening of the real estate market, his country club investor capital cannot scale up alongside of him and most of his past investors have dried up. We had a couple conversations and he showed us his financial models for some upcoming transactions. They were structured with returns for country club investors. We clearly explained to him how Ultra-High Net Worth Families generally structured deals and within days, he has re-structured his financial models. His mentality was that if his transactions could not support these return models, they would not be attractive investments for him to pursue. We have a positive and productive relationship to this very day.
We have also worked with a development firm who has created a very strong track record with building residential ground up towers within their regional market. With their past projects, they primarily raised capital from several high net worth foreign investors. They paid these investors typical country club returns and enjoyed a positive experience on their past several projects. However, they are scaling up with multiple projects over-lapping at one time and slightly larger transaction sizes. The adjustment towards a much different financial model stunned the developer initially, but now they find themselves with a multi-billionaire strategic partner who they enjoy a tremendous relationship with for their next several projects.
Nonetheless, the bottom line is finding the alignment of interests and understanding the perspective of the Ultra-High Net Worth Investor. They are very selective with the operator and developer partners they choose and their capabilities to execute before the transaction, then they look at the actual transaction. When reviewing a transaction, these private families enact a comprehensive risk management process to determine the viability of the location and other fundamentals of the opportunity. And once they get past the risk and are comfortable with the opportunity, they are seeking compelling returns in exchange for writing a large check.
We are very pragmatic and selective with our philosophy towards bringing together strategic relationships. Please contact us if you would like to discuss your options for attracting a strategic partnership or a specific transaction.