Exploring the Rise of Entity-Level Investing in Real Estate
INTRODUCTION
After numerous in-depth conversations with top Limited Partners (LPs), Investment Managers, Consultants and other industry participants, it is evident that entity-level investing is a prominent topic of discussion, but many are unclear about what long-term implications an entity-level deal will have and what factors to consider. Alliance Global Advisors (Alliance) is highly integrated across the institutional space and in educating, understanding and facilitating complex discussions and analysis of entity-level investment options. To dig deeper into this topic, we interviewed over 20 industry participants (pension funds and other LPs, service providers, consultants and Investment Managers) throughout 2H 2023 and 1H 2024 with the intent to provide a comprehensive analysis that will help Investment Managers in discerning the key elements to pursue in a strategic partnership and navigating the complexities of growth equity.
Finalized in 2024, our full Entity-Level Investing Analysis provides us with deep insights into the terms, structures and alignment of interests essential for successful entity-level investments. Although this comprehensive analysis is only available to Alliance Clients, we wanted to share the following takeaways from our analysis.
We would like to thank David Robertson, CEO & Chief Investment Officer of FrontRange Capital, Kevin Stahl, Managing Principal and Wendell Osborne, Managing Principal at Skyhawk Capital Advisors, for their insightful contributions on this topic.
Stay tuned later this year for an exclusive webinar with Juniper Square, where we'll dive deeper into this topic.
UNDERSTANDING ENTITY-LEVEL INVESTING IN INSTITUTIONAL REAL ESTATE
The concept of entity-level investment involves making capital investments directly into the management entity, platform or in singular or multiple vehicles rather than individual properties or as a traditional LP in a private fund. This method of investing can be structured in various ways and typically gives the Capital Provider additional exposure to General Partner (GP) economics.
The growing popularity of entity-level investing is driven by several factors, including the potential for enhanced financial returns, diversified risk and strategic growth opportunities for both Capital Providers and Investment Managers. The lack of exits from prior investment portfolios has put many Investment Managers in a corporate liquidity crunch, which makes raising the next vehicle or engaging in strategic growth challenging. Many Capital Providers are looking for ways to deepen their relationships with Investment Managers and diversify their risk profiles. Entity-level investing typically has a wide range of negotiable terms, which allows flexibility for each side of the deal to align interests.
Entity-level investing often involves custom structures designed to meet the needs of both the Investment Manager and Capital Provider. For ease of discussion, we’ve grouped the structures into the following categories:
Platform Investments: Capital Providers may take a minority or majority share in a real estate entity, sometimes influencing control and decision-making or sometimes from a passive stance. The Capital Provider will participate in both the upside and downside of the platform performance in exchange for a share of the promote and net income of the platform.
Co-GP Structures: Capital Providers invest capital alongside the GP equity in a vehicle in exchange for property-level returns and a share of the promote of the GP. These investments can vary in terms and structure but often lead to longer-term partnerships, as the Capital Provider does better when the Investment Manager is successful at future fundraising.
Hybrid/Flexible Structures: Recent trends include innovative agreements that allow for tailored involvement and risk-sharing between Capital Providers and Investment Managers. These structures are configurable to achieve the most beneficial structure, effectively align the interests of the parties involved and have the flexibility to adjust over time.
As Investors become more sophisticated and continue to push for higher real estate returns, some are exploring creative avenues to get access to GP-level economics through a mixture of the entire platform, the OpCo, the promote or the management fees. Many Capital Providers are able to be flexible with the investment structures they offer.
MOTIVATIONS FOR BOTH SIDES OF THE TRANSACTION
Capital Providers are motivated by several key factors when considering entity-level investments:
Efficient Capital Deployment: Enables quicker, more flexible investment decisions
Enhanced Returns: Combines fee income with property-level returns
Geographical and Sector Expansion: Facilitates entry into new markets and property types
Control and Negotiation: Offers varying degrees of control over investment decisions
Investment Managers seek entity-level investments for different reasons:
Operational Improvements: Enhances management and operational efficiencies
Capital Needs: Addresses both property-level and broader organizational capital requirements
Strategic Expansion: Supports succession planning and the expansion of new strategies or business lines
The alignment of interests between both parties is crucial in these transactions. Entity-level deals often involve long-term partnerships, requiring both sides to benefit mutually. This necessitates a high level of due diligence and a clear understanding of each party's goals and expectations. The level of control that a Capital Provider will have in the Investment Manager’s operations within a deal varies greatly.
VIEWPOINT OF ACTIVE INVESTORS & SERVICE PROVIDERS
David Robertson, CEO & Chief Investment Officer of FrontRange Capital, has seen firsthand the evolution of the entity-level investing industry. “FrontRange has invested in GP-Stakes since our founding in 2010. GP-Stakes investing was a rather novel concept when FrontRange started making these investments, but over time, the Investor community gained a better appreciation of the alpha generated by the GP-Stakes strategy, and now it is increasingly mainstream.”
Kevin Stahl, Managing Principal at Skyhawk Capital Advisors, has been involved in a number of recent entity-level transactions. “Skyhawk provides highly tailored strategic advice along with capital markets execution. Our process initially focuses on an in-depth evaluation of a company’s strategic objectives and priorities very early in the process; what does the company want, what does the company need and what are the potential viable solutions?”
David Robertson notes a range of structuring options to meet a company’s needs. “FrontRange specializes in real estate GP Stakes investments, both at the company and property level. Company level investments, often referred to as platform investments, are typically structured as a form of convertible debt, similar to non-real estate private equity investments. Property level investments are typically structured on a programmatic and exclusive basis, with the Capital Provider receiving a share of the GP promote and transaction fees for providing a portion of the required GP co-investment in each property joint venture.”
Kevin Stahl notes, “Typically the three most heavily negotiated terms center around exit provisions, governance and valuation. While it is important that Investors have the opportunity to monetize their investment, Sponsors want to ensure that they can retain control of their companies long-term. It is always a delicate balance that requires creative structuring that maintains alignment of interests.”
On the alignment of interests, David Robertson comments, “FrontRange’s economics reflect the additional value we bring beyond our capital investment, especially in the areas of capital formation, strategic advisory and other value-added services. As capital formation continues to be challenging for middle market real estate companies, we believe both operators and investors will increasingly see the benefits of partnering with Co-GPs.”
SUMMARY
Entity-level investing offers a strategic pathway for both Capital Providers and Investment Managers looking to leverage financial and operational synergies. As the market continues to evolve, these investment structures are becoming integral to strategic growth and diversification in the real estate sector. Many Investment Managers are entering this market, looking to attract growth capital to expand their business, cope with the rising cost of capital or other needs that could be satisfied by partnering with the right Capital Provider. More than anything, the parties involved should both have a sound understanding of what they are looking for in a deal.
ABOUT ALLIANCE GLOBAL ADVISORS
Alliance Global Advisors is a women-owned consulting firm focused on empowering the institutional investment community to elevate best practices. Advising clients with over $620 billion in assets under management, Alliance partners with organizations to provide an independent perspective and innovative approach to critical strategic initiatives. Our partnerships allow senior management teams to focus on what matters most: diligently managing client capital, creating value and delivering exceptional returns in a performance-driven market.
Disclaimer: This blog was originally published in June 2024 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance Global Advisors.