In the last cycle I assisted a Fort Lauderdale real estate investment firm, as it broke into the institutional market and took its acquisition capacity to a new level. This was accomplished because the firm’s principals had raised enough funds on their own to acquire an initial portfolio –and subsequently attracted an equity investment from a large Midwest conglomerate. This model still works today!
That additional equity allowed the firm to obtain $7.5 million in third-party bank financing. As a result, the real estate company acquired twoSouth Florida office buildings in prime locations. Equally important, the firm was able to establish a relationship with an institutional investor that will open the door to future ventures. This type of transition from Main Street to Wall Street will occur more frequently as the current market cycle evolves.
Experienced entrepreneurs break away from larger companies and developers try to assume greater control of their financial destinies. At the same time, pension funds, insurance companies and other institutional investors are seeking out promising investment opportunities.
For developers, operators and investors, the benefits of teaming up with an institutional partner are numerous.
*Access to a continuous stream of capital.
*Funding with a lower cost of capital
*A defined set of underwriting parameters to source future deals.
*Increased credibility in the market to attract new transactions.
*Increased credibility to execute transactions.
*A platform to grow the business on a consistent basis.
Dealing with institutions also depersonalizes investment money. Principals can raise the funds they need in boardrooms rather than living rooms, avoiding the personality issues associated with asking family and friends for money.
However, smaller firms hoping to tap this market must understand how the game is played—and it is the big institutions that determine the rules.
First, it is important to understand that there is a common growth pattern for real estate companies. A premature attempt to reach out to an institutional investor is doomed from the start.
Typically, a real estate company seeking to buy property will raise funds first from the principals, ten seek out additional equity from family, friends and business associates. In most cases, the maximum raised by this first stage of financing is $1 million to $2 million—well below the minimum threshold of a major institution.
However, there are “one-off” institutional sources that may be interested in exploring a single transaction with an entrepreneurial-oriented “family-and –friends” firm or partnership. This type of investor may be able to contribute $3 million to $5 million or more, allowing the investors to qualify for enough debt financing to complete a major acquisition.
When the entrepreneurial firm is ready to move from family and friends to institutional sources, the firm should contact a experiences investment banker or consultant to determine the best potential sources of institutional funding—and the requirements needed to obtain that money. For example, institutions have very strict financial reporting and documentation requirements that must be followed scrupulously by the local firm.
The entire process can be likened to a courtship that must be orchestrated by the principals or an outside professional. Like arranging a dinner date, the right institution must be approached, a level of interest must be verified, the timing must be right and the details of the transaction must be confirmed.
One important step is to create a written business plan that stands out from the countless other proposals that institutions receive daily. A clear business strategy, a good “story teller” and a credible sponsor of the plan are important components, as well as a proven track record on previous investments.
If the institution goes ahead and funds that first transaction, the local firm suddenly becomes more attractive to other institutions. After the small firm has experienced this rite of passage, it has joined the institutional “club.” The entrepreneurial company may then be able to attract a number of potential institutional investors on bigger transactions in the future.
Most institutional investors like transactions in the $30 million to $50 million range—either a large single property or a package of smaller ones. To reduce potential risks, the decision-makers prefer to deal with known entities with an established institutional track record.
It is not easy to break into the institutional equity market. In most cases, success requires determination to overcome unexpected difficulties and a passionate belief in the ultimate goal. But the rewards are worth the struggle.
For more information, read our article on Real Estate Merchant Banks.
