The Advantages of a Lean Investor Group
Not for small and passive investors: Club Deals are tailor-made solutions for real estate investors seeking higher returns at manageable levels of risk.
By Nicolai Striewe
MUNICH, January 4, 2018. And then Alice met the Cheshire cat: “Could you please tell me which way to go?” “Well, that depends quite a bit on where you want to go,” answered the cat. “Oh, it really doesn’t matter,” said Alice. “Then it really doesn’t matter which way you choose,” replied the cat.
Just like Alice, many investors are not always certain of the goal they want to reach. And there are many ways to build a real estate portfolio. The simplest one is to buy shares in real estate corporations, or in real estate investment trusts (REITs), or to buy shares of open-end real estate investment funds. This path minimizes investors’ time and effort. And investments can be made with small amounts. Furthermore, these investments are, to a certain extent, pre-diversified (“blind pool”), as they usually consist of numerous properties, which in turn reduces cluster risk. Furthermore, in the event of a property’s unexpected loss of rent, or the delayed development of a project, the situation can generally be offset by other assets in the portfolio. And at the same time, shares are readily marketable allowing the investor to buy or sell depending on the market. In addition, the regulatory framework for these forms of assets also guarantees transparency and professional reporting. Returning to the question posed by the grinning cat: “Where do you want to go?” If the goal is to passively build a pre-diversified real estate portfolio then the path offering the least effort is the one leading to open-end real estate investment funds, REITs and real estate corporations.
Having said all that, why are any other forms of real estate investment even necessary? The answer is that some investors are pursuing other goals. Very wealthy private investors and Family Offices are experienced in dealing with more direct forms of investment such as Club Deals, or joint capital investments involving a group of wealthy investors. Club Deals are generally more aligned with the asset, meaning that the term of the investment is the same as the length of the project itself. Club Deals usually invest in only a single property. Furthermore, they comprise just a few investors who make decisions based on detailed business plans including financial calculations and sensitivity analyses. The more professional the investor the greater the value of Club Deals. They make it possible for investors to independently select optimal choices from a range of individual properties and business plans. Furthermore, lean investor groups also make it easier for investors to ride out turmoil during times of crisis.
Value-add strategies, in particular, which, for example, focus on renovating, repositioning and development of a property, can be clearly presented to Club Deal investors: Moreover, a homogenous and lean investor group can respond professionally to stabilize a situation if additional capital is needed in a financial or market crisis. In contrast, major real estate funds frequently find themselves blocked from financially stabilizing their investments during a crisis due to their large and heterogeneous investor pool, leaving only one option: liquidate the fund. This was frequently the case for many open-ended real estate funds during the 2008 crisis in the financial markets when properties had to be sold at very unfavorable conditions. This resulted in high losses for investors.
The path to a Club deal is the sensible choice for an investor who wants to avoid blind-pools and prefers to build a selective and efficient real estate portfolio offering top levels of management performance and strong returns.
Club Deals are becoming more and more important for institutional investors as they are currently under great pressure to invest and deliver returns. These investors increasingly value the transparency of knowing when capital will be required and exactly where it will be invested. Professional investors want to closely examine all aspects of a real estate project before they commit their capital – and this is only partially possible, in the case of a fund. Furthermore, the composition of the group of investors in a Club Deal is clearly defined thus ruling out subsequent additions of new investors who might not be suitable for the group. Club Deals are also fully transparent for tax purposes and may be flexibly structured to meet different needs.
Conclusion: An investor seeking the right way to build a real estate portfolio should first ask “Where do I want to go?” Because if the goal doesn’t play a role, as was the case for Alice in Wonderland, then any way is the right way. For investors interested in a passive blind-pool investment, a listed investment in a real estate corporation, a REIT, or an open-end real estate investment fund is a convenient solution. In contrast, for professional investors, like Family Offices or very wealthy private and institutional investors, investing in a selective real estate portfolio through Club Deals featuring a lean group of investors is a more appropriate choice.
The author works for Taurus Investment, a private equity firm in Munich. He is also a lecturer for risk management at the European Business School (EBS) in Oestrich-Winkel.