In the best of times, investing is a mix of science and art
Investing in commercial real estate always entails a complex mix of science and art, CBRE officials like to say. The precision of that alchemy is at a higher premium now given market uncertainty.
In its latest “Weekly Take” presentation, Dallas-based CBRE – the world’s largest commercial real estate services and investment firm – attempts to assuage those anxious on raising capital amid uncertainty. To that end, the firm invited FD Stonewater principal Jeff Toporek and Continental Realty Corp. CEO JM Schapiro to share their secrets on prudently raising capital and effectively putting it to work even amid uncertainty.
Spencer Levy (pictured top), global client strategist and senior economic advisor for CBRE, moderated the discussion.
Schapiro began with something of a Funds 101 mini-class, detailing the different types of real estate funds that are out there. “When I think about the fund landscape, I think about deal by deal. So that's not even a fund, that's where you go raise money on an individual deal basis. And what that means is you're not cross collateralized. Then I think you start to get into a fund. A fund is where you go raise money and the money's given to you and you're investing it.
“And those are cross collateralized. And that can be a closed end-fund, meaning it
has an end date that is known; or it can be an open in fund, meaning it does not have an end date and you're valuing those properties in a annual or quarterly basis.
“And then you can get another side, which is the other side of direct, but is programmatic or some large joint venture partner will give you equity and you're in a box and as long as they quote, approve it, then you can go invest and split the fees from there.”
Toporec weighed in: “There are always little nuances here or there, whether it's in an open-ended structure or whether it's non-traded rates. Obviously, how the public rates it all comes down to what is the right fit for what you're trying to do and what is your investment strategy and who do you want your investors to be?”
How do you get capital for commercial real estate?
The refresher out of the way, panelists addressed the raising of capital. While it may sound counter-intuitive, Toporec suggested he welcomed the market uncertainty. “We
love volatility. We love choppy markets because then you get to show your true DNA and the fabric of who you are as a firm in the capital raising landscape,” he explained. “We constantly hear, ‘Oh, it's difficult to raise money.’ Candidly, if you have a differentiated product and a differentiated company and you approach your strategy different than other things that they're seeing, you will get meetings. Some of those meetings may not be, ‘We're going to write you a check right now because we love it.’”
The mindset pays off future dividends, he suggested: “But you're building a relationship that at some point, they're going to remember that and they are going to want to write you a check at some point in the future. It's a long game of capital raising where if they're hearing a niche strategy and they're hearing a differentiated firm, you will stand out. I guarantee that.
“In the last 90 days, we've had 65 meetings on the capital raising side. And believe me, people have other stuff that they could be doing. They're only being set up because they're interested to hear that niche strategy, that niche story that you know what is - You're different than most other firms, and those have led to second and third meetings. And so - while the world is volatile, we kind of like that because we can then actually stand out.”
Schapiro was similarly upbeat: “We raised last year $350 million, plus or minus.
It was a great year for us. We created some products that investors were interested in.
And I think what we are going to see and by the way, and it's just not an easy fundraising environment because certainly when you get to the institutions, there's a denominator effect, right… So you really need to create something that resonates with them.”
Why is differentiation so important?
He agreed with the notion of differentiation: “You need to differentiate yourself. But I think what you're also starting to see is, in the world that we're in today, there will be some distress for some people who have not structured their deals appropriately and are going to feel some pain, and that creates opportunities for groups like Jeff and I on the buy side. And so we are sort of excited about seeing that part of it, in terms of being able to take advantage of those opportunities.”
In the way of a historical perspective, Schapiro described the capital-raising strategy at the launch of his firm versus how it’s done today. “We started in 1972 when we bought our first apartment community in Brooklyn, Maryland, for $3,000 a door, when rents were $59, including utilities. And in that case, we were using pretty much our own equity. The entire deal was about $600,000. And then we bought our first shopping center in 1978 in Fairfax, Virginia, for $26 afoot, and that it once again was us using our own internal equity.
“And so we built the company from there, basically using our own equity. It was our family and a gentleman named Jack Luetkemeyer’s’ family. And so as that company grew, it was really predominantly our own equity until about 2010 or 11. And then in 2011/12, we started to look at transitioning to a different way to basically leverage our equity and provide more opportunity for our people and that's what I think the conversation we're going to have today is, ‘Okay, how do you make that transition from using your own equity to using other people's equity with your own?’
“And so… over the past 10 years, we've raised almost a billion dollars from a value add and multifamily fund where those sat together in 2012, 2015 and 2018 to today, where we raised a separate fund that invested just in core multifamily and then a separate fund that raised just focused on opportunistic shopping centers that we just closed.”
Institutional capital is part of the mix, he added: “Yes, we have institutional investors and some of those would be large registered investment advisors. Some of those could look like endowments, foundations, or groups like that.”
It was then Toporec’s turn down memory lane: “We had a joint venture with Fortress, and then we had a private capital fund that invested side by side with them, and we actually did two joint ventures with them. And then that sort of evolved over time. And some of the folks that left Fortress went to Garrison. We did another adventure with them and then in 2010 we actually did a fund, but it was a sole investor fund with a corporate pension fund so that it was the DuPont pension.
“And that was focused mostly on federal government at the time. And then after all, those funds had kind of liquidated and had their successes, we actually did almost all of our deals through private capital. So it was our own money as well as people that we know. We never outwardly marketed, we never really needed to.
“And then ultimately, as we took a step back, we started to realize, you know, we're basically raising a fund for each individual deal from a transaction cost basis and really not giving our investors the benefits of being part of a fund. And so we launched an Evergreen fund in December for our single tenant strategy that really allows our investors to get the benefits of portfolio financing, getting one K-1, being able to do 1031 exchanges and things like that. So it's been an evolution over 20 years and I think the capital markets change and you've got to figure out what your business plan is and what's the right fit for you at that moment.”
However one goes about raising equity, Schapiro noted, the surprise factor should be avoided: “Regardless of how you raise your equity, making sure that there are never any surprises, that you overcommunicate everything that's going on, you explain everything that's going on. If you're going to build a relationship with whatever that equity source is, because it's really hard to raise equity, right? It's hard to get somebody to give you money.
“Once they've given you that money, the most important thing you want to do is make them comfortable that you know what you're doing, that you're communicating clearly, that there's never any surprises.”
Dovetailing on the theme, Toporec added his insight: “Wherever your capital is coming from, if you run your operation as if your capital is always institutional, you're going to be fine.”
Levy then asked for distinctions between running each deal individually as opposed to co-mingled into a sole vehicle. While co-mingling yields advantages toward diversification, many developers adhere to the piecemeal approach: “I know many developers, big developers who have never moved away from the deal-by-deal approach because unfortunately sometimes you have a bad deal and it could drag down the rest.”
Toporec offered his view on the matter: “On a development structure, I think that does make sense, kind of doing deal by deal,” he said. “But if there is something thematic where you can have something programmatic and it doesn't necessarily have to be a fund, then sometimes it makes sense to do that. Every investor and every developer would prefer to have their deals be one-off so that they can earn their promotes. So it really depends on what the mission is and what the strategy is and to see whether that makes sense. But I think if you could do deals one off… everybody would do that solely because their promotes aren’t crossed.”
At the end of the day, everybody has their own preference: “And then there's also a discussion of, okay, do you get an asset management fee, right?” Schapiro asked rhetorically. “Which means a fee on the invested or committed capital. Are you taking fees on acquisition dispositions? We do not, but plenty of people do. There are so many different ways to structure it, and everybody has their own way.”
Levy addressed the concept of alignment of interests. “And you want to be
absolutely aligned with your investors,” he added. “Some people might suggest that they're in it for the fees, they're not in it for the overall performance of the assets, and maybe it's better to be smaller.”
Toporec offered his take: “We put that into a couple of different categories. So if you raise a lot of money, you're a money mover and you need to make macro level bets. There are some groups that are excellent at making macro level bets where they're making big bets on companies and things like that.
“For us, everything starts at the asset level and each asset has its own business plan and we are solely focused on executing that business plan for that asset. Now, does that fit into a larger portfolio and how we manage the portfolio and prune it based on credit and industry and lease expiration? Sure, but the business plan is at that asset.”
Added Schapiro: “It's not about how much money you can raise, whether you're raising $200 million or $1 billion. To us, it's about how much you can invest doing the same thing that you've been doing, because that's why people are giving you money. So if you think about our first fund in 2012, which was $100 million, and it took us a very, very, very long time to raise like 14, 15, 18 months, we came back to our second, which we would call fund four in 2018, and we had so much money chasing us and it was like in four months we said we were going to raise 150.
“We could have easily been at two in a quarter, easily. And so we said no, that we feel comfortable at the 150. We took it up to 165 because there were a few people you just can't leave out. But we left $50 million on the table because that's what we felt comfortable we could invest. And I think that's really important.”
Toporec agreed: “I think that's exactly right. And for us, what we said to investors is we want enough money to continue to do smart deals. We do not want money that we have to feel pressured to get out.’
Levy asked the panelists how they try to structure their fund. Schapiro’s response came first: “From a shelf-life perspective, you want to give yourself long enough to invest in that asset class that you're not pushed. So we always say run our office, patience will be rewarded. So we think about it as saying, okay, most times we're looking at three year investment period and probably a third of those three years. But we've been in situations we raised a fund in 2011, we were buying real estate tax certificates in Florida. It’s on paid real estate taxes. So what that means is you have to show up at those sales with the cash.
“So we raised $90 million. It was the second year we did it and we showed up
at the sales. And there's $2.2 billion of sales in that year and the cap rates had
compressed so much or the yields that we ended up buying $3 million. So we have
$90 million in the bank, we buy $3 million. It was sort of Armageddon. We just couldn't
chase the yield down because we suggested we’d get a better yield.
“So what we did is we wrote our investors a letter and said, we are giving you back all your money. Like we can't run a $3 million fund, you will make zero. And so that built us more goodwill than maybe anything we've done in terms of returning that. And we ate all those costs. So we ate a fair number of costs to sort of put that whole thing together because it's not what people should understand is there is a lot of work that goes into setting up a fund. There's a lot of time, there's a lot of energy, there's a lot of time with lawyers, especially when you're talking about institutional funds, right. It's just a lot of work.”
It's also a lot of money, Levy added. Toporec agreed: “You're investing in infrastructure, you're investing in technology, you're investing in people. You've got to make sure that you're really ready to do it and your firm is ready to do it. You know, training people to do the right things. You've got compliance. You kind of got to go all in. And that includes legal, accounting, whatever, registration filings that need to happen.
“There's a lot of thought behind it and you have to create a roadmap and a plan and set yourself up with milestones of how you're going to hit them in addition to dollars. And it takes a huge amount of time. You know, the cost is one thing, but the amount of time that it takes to actually capital raise – I mean, I was home for a total of six days in the month of February. It just takes time.”
Toporec was asked where he saw the market today, and when he saw it improving. “Oh, it's really interesting with the economy, where it is with inflation and interest rates and we have two exogenous events that we're dealing with. You still are dealing with the pandemic and you're dealing with a war in Russia and Ukraine. And those are two massive things that have had an impact on the world economy. You have the regionalization of the global economy, partially in response to that, but that was sort of coming along the way.
“And so you have this fundamental shift in the US economy that's happening where we could in the next five years actually be a net exporter. In our Southeast logistics business, we're just seeing company after company announcing manufacturing moving to the US. These aren’t US companies coming back. It's in addition to that. So you've got the cumulative effect there where you've got a real engine for economic growth, transformative economic growth. But you do have these pressures of inflation.
“The labor part of the economy is super, super tight. So those two things are just fighting against each other and it's going to be interesting to see how it plays out. My bet is that the economic growth engine actually wins because those are 50-year bets. They're not reactive to where interest rates are today, in this moment in time.”
Noting he was an investor in one of his firm’s earlier shopping center and multifamily funds, Levy added that “…one of your more recent funds is saying we are going to opportunistically look for distressed shopping centers. Is that one of the ways you're dealing with the market conditions we have today?” he asked Schapiro.
“Yeah, I mean, when we raised that opportunistic shopping center fund, our view was
having done it for 40, 50 years,” Schapiro began. “That we felt like it was an opportune time to go buy shopping centers. There are clearly less people looking to buy those centers today. We've had a long track record of doing it successfully.
“I do believe institutions are going to start to come back to that asset class. But when we really think about the economy, we think about interest rates, right? Because that's a lot of what controls what happens with cap rates… In 1983, ‘84, ‘85, we were buying apartment units and borrowing at 18%, 18 and by the way, those ended up being very good multifamily properties, some of which we still own. So our view has always been clouded by that. We know that interest rates can go up. We've seen in the past and it's one of the reasons why we're just fixed rate borrowers across the board… We know we can't control interest rates, but we know that if a deal looks good at a point in time when we're buying it and we can fix that interest rate for X number of years, we feel good about that.”
Toporec strongly concurred: “You have to have conviction over the asset that you're buying. And real estate is a slower moving asset class and at any point in time you could claim the value goes wildly up or wildly down. But unless you're transacting, it doesn't really matter. You need to be really evaluating when you're purchasing it: ‘Based on interest rates today, am I hitting my targeted returns?’ And that means you should be able to buy in pretty much any market.”
What is CRE in investment terms?
The strategy used now at his firm will remain in place for the time being, Schapiro said: “We're just going to continue to do what we've been doing, right? So I think we will continue to raise funds on the shopping center side and on the multifamily side of our business. Look, we've owned office, we've owned industrial, we owned the largest movie theater chain in Maryland. So we are entrepreneurs. But when you start to think about taking other people's money, I wanted to make sure we were doing it in only what I thought we were the best at.
“And so I think that we can compete with anybody who's in the multifamily as an integrated owner operator, which I think is very important in the Southeast, where we spend a ton of our time. I mean, we've been in the Southeast since 1983 investing, and so it's areas we know. So I think we're just going to continue to do what we've been doing.
“I think one of the things that people should understand is it is really not easy to raise money. It takes a lot of effort. It takes a lot of time. It will take you just much, much, much longer than you think. For those of you who are thinking about doing it as your first fund, just put in a year and then you're probably at 18 months, it just is what it is.
“[In terms of] the deck, everybody does not think about how long that deck takes to put together because you really want to make sure you get your story right and then you got to have your attorney read it and make sure you got all the right disclaimers in there. And you’ve got to be really careful about what you say. We’re very careful what we say even today. It's just there's a lot to think about.
“Getting your attorney to write the documents is the relatively easy part. They're going to have a boilerplate document. They're going to put some risks in there. That's going to be a long, long, long, list that, frankly, I don't think most people even read. But it's then getting back to that deck and then building those relationships or taking your existing relationships to the next level.”
Toporec echoed the sentiment: “Your firm has to be ready. I said that before, and it's beyond just the pitch deck. You've got to prove to people that you've got a verifiable track record. That means if they do due diligence on you and really start going into the weeds, you know, you've got to verify every single deal and what their track record was. Well, that takes a lot of time. If you've been around for 20 years and you haven't been doing it right at the outset, I mean good luck trying to recreate that. It's really, really tough.
“It took us probably seven months before we even hired an attorney where we were writing the pitch deck and putting together all the materials, refining the message. You've got to be able to tell the story in a way that's conscience and meaningful to differentiate you from everybody else.”