Small Real Estate Funds Hold Big Edge In Growing Investor Wealth

Topic:  • By Michael Episcope • July 26, 2017 Views


Private equity real estate, once considered a chancy alternative investment, has gone mainstream. One sign is the cash stockpiles of asset managers such as Blackstone Group, Starwood Capital and Apollo Capital Management. What does this mean for the high net worth individual (HNWI) trying to create wealth?

The Blackstone Group, known for its opportunistic real estate funds, raised a $15.8 billion private real estate fund in 2015 — the world’s largest-ever at the time. It also launched its first open-end core-plus real estate fund in 2014, which is up to $17 billion in assets today. Brookfield Asset Management closed a $9 billion real estate fund last year, Lone Star Funds raised $5.9 billion for its latest real estate fund and Starwood Capital Group set a $6 billion target for a new opportunistic fund.

Certainly these megafunds validate the role private equity real estate can play in a wealth-creating HNWI portfolio. But in private equity real estate, does size really matter? What is the track record for small vs. large real estate funds? We’ve crunched the numbers, and the results are surprising.

As I noted recently in the Huffington Post, we analyzed Preqin’s return on investment data for private equity real estate funds that made their first investments between 2005 and 2015. For funds with more than $1 billion or more in assets, the average net internal rate of return (IRR) was 5.7 percent. But for real estate equity funds with less than $200 million in assets, the net IRR was 11.2%. Smaller asset managers outperformed the big money by 96%.

Though we closed our largest fund ever at $157 million, we’re still a niche player facing managers like Apollo and Blackstone. Yet our wealth-creating strategy allows us to consistently outperform our bigger peers. Fund III has the capital resources to acquire approximately $600 million in commercial and multifamily real estate. And thanks to our track record, we’re not deviating the formula for our first two funds, which are on track to produce a 24% annualized net return.

Our smaller size and boots-on-the-ground capabilities give us a big advantage: We can scout for value in corners of the commercial real estate market neglected by the megafunds, maintain price discipline and execute flawlessly to maximize value and profits.

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Let’s break down how this strategy helps HNWI create wealth:

Scout for value.  We continue to focus on deals between $10 million to $40 million. Bigger funds neglect this price range because they’re focused on megadeals. We use our local market expertise to size up properties on and off the market and find diamonds in the rough.

Maintain price discipline. We combine our first-hand knowledge of a market with solid financial analysis to make sure we’re buying at the right price. Our relationships with landlords, access to capital and reputation for performance allow us to acquire properties off market or at favorable prices.

Execute flawlessly to maximize results. Our business model adds value to properties by funding improvements that make an immediate difference in leasing rates and substantiates higher sales prices. Our size helps us follow through on the execution of every detail of our project plans, ultimately maximizing profits while we own a property and when we sell it.

Another key to our superior financial performance traces to Origin’s roots. Dave Scherer and I became partners to invest our own money, and that origin story has kept us focused on creating wealth for our HNWI investment partners. The two of us invested $11.7 million in Fund III, and $44 million in Origin since the company was founded. These table stakes keep us aligned with our 550 investors.

That’s an unusually large investor group for a small private equity real estate firm, which we’ve developed with a platform built for high net worth individuals. It speaks to the faith our HNWI partners have placed in our asset management approach. It’s a sound strategy that truly runs contrary to the direction of the large real estate funds, yet has yielded superior results. Our growth will create wealth for more investors, and that’s a big deal.

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Michael Episcope

Michael Episcope formed Origin Investments in 2007, along with Co-CEO David Scherer. He has more than 25 years of investment and risk management experience.