Prior to Fund III’s first opening deadline, Origin Cofounder and Principal Michael Episcope wrote about the importance of finding the right real estate investment manager in a column for Commercial Property Executive. He made the point that when it comes to private real estate, it’s “less about what you invest in than whom you invest with.”
The following are the six questions he recommends asking in order to separate the good managers from the bad.
1. What is the manager’s financial stake?
The manager should have real skin in the game. Managers who invest significant capital in a project will have goals that align with the investor’s. Look for entrepreneurs who invest their own capital, have raised money from friends and family, or have substantial funding from the firm’s employees. For example, Episcope and his partner David Scherer and have committed $11.7 million to Origin’s latest Fund III.
2. Does the manager have a team?
Acquisitions, asset management, accounting and investor relations all should be handled by separate departments. Bigger isn’t always better, but there is a happy medium between a large bureaucratic institution and a two-guys-and-a-truck operation posing as a manager.
A 2015 report from PwC makes the case that investors in alternative investments, such as private real estate, “require higher touch, with more interaction and education, than mutual fund investors due to the complexity.”
3. Are there potential conflicts of interest?
Vertical integration can work for companies that invest their own capital, but those with in-house construction, property management and asset management divisions might be susceptible to conflicts. Because the decision to sell shouldn’t be an internal conversation about, say, protecting a property management revenue stream, it should be a discussion about what’s best for the client.
4. How are fees charged?
Real estate requires active management and a great team to be successful, and transaction fees help pay for that team. But fees should keep the lights on — not be a profit center. Look for a fee structure that is largely performance-based, so the manager wins when the investor wins. Also beware of joint ventures; two managers instead of one can mean double the fees.
In general, run from investments that advertise little or no fees or, at the other end of the spectrum, charge exorbitant fees upfront. A good standard: The best managers invest more than 95 percent of every dollar that comes through the door.
5. How strong is the balance sheet?
The balance sheet tells you if the manager has the capital to fulfill its obligations over the long run, such as meeting payroll, funding deals and solving problems when things go wrong. A large cash position and limited leverage indicate that the manager who oversees the fund will be able to weather short-term setbacks and work toward long-range goals. Investors also should look for transparency in financial reports on the manager’s past deals.
6. What’s the manager’s track record?
Managers should have at least 10 years of experience in the industry. News coverage can suggest the company’s scale and expertise. Also, look closely at how the manager’s last five sales have panned out in realized returns.
Ask your manager to tell you the story of an investment that went poorly and how it was handled. How the manager answers this question will tell you something about their honesty and integrity.
The above article is excerpted from a June 8 article by Michael Episcope that appeared in Commercial Property Executive.