5 Strategies That Make Real Estate Fund Managers Profitable
Warren Buffett, the legendary value investor, has a saying that gets to the heart of Origin’s value-added investing strategy: “A great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem.”
Taking on solvable problems, and coming to the table with a solid business plan to fix them, is one of our enduring value-added real estate strategies. And it works in up and down markets.
As real estate investment fund managers, we have found that by adhering to these five strategies, we can both limit our risk and maximize investment value.
1. BUY RIGHT.
In real estate, disciplined investing starts with buying right. We find profit by looking for the right property in the right location at the right time, and, most importantly, at the right price.
This takes discipline and time.
For example, Denver is one of our target cities, and it took us five years to find and acquire our first investment there, Denver Corporate Center I (DCC I). Here we are adding value, stabilizing the tenant base and commanding higher rents through common-area and amenity improvements. Most significantly, we were able to acquire the property in an off-market transaction at a price 15 percent below where competitive, neighboring properties have sold.
2. USE DEBT RESPONSIBLY.
Just because you can leverage a property up to 90 percent doesn’t mean you should. We match our debt-to-equity ratio to our business plan. We also don’t use preferred equity, mezzanine debt or other instruments to get higher returns because they expose us to added risks. Our returns come through increased operational performance of the real estate and not through financial engineering.
3. DON’T CROSS-COLLATERALIZE ASSETS.
Cross-collateralization has taken down many funds. By guaranteeing loans at the fund level, or guaranteeing multiple deals under one loan, the manager has exposed the fund to unnecessary risks and has destroyed one of the best attributes of the fund, diversification.
Every deal in our funds is structured as a separate venture. When we buy 15 assets, they are essentially 15 separate companies. If something goes wrong with one investment, it won’t drag the fund’s other assets down with it. This is basic risk management at its core and sounds simple, but many real estate fund managers simply don’t adhere to this concept.
4. BE FULLY ALIGNED WITH INVESTORS.
A real estate fund manager’s compensation needs to be aligned with performance and not simply guaranteed. Skin in the game is key. My business partner, David Scherer, and I have personally invested $42 million alongside investors since 2007. Further, our acquisition officers’ compensation is tied directly to how well an asset performs and not by transaction volume.
5. ANCILLARY REVENUE STREAMS CAN CREATE CONFLICTS OF INTEREST.
Being vertically integrated can create synergies, but it can also create conflicts of interest between management and investors. An investment manager who also manages the properties has an inherent conflict of interest because a property can easily generate tens of thousands of dollars in management fees. Thus, the dialogue of whether to hold or sell can easily turn to the well-being of the employees and the property management revenue stream. That can compromise a decision to sell the property at the optimal time and price. For that reason, we believe it’s best practice to hire the best third-party management team for the job.
When value-added real estate projects go wrong, it’s usually because the manager has failed to follow one or more of these proven risk-control strategies. Investors will be rewarded if they’re vigilant about these behind-the-scenes details and ask questions about how risk is being managed.