Financing Focus

Changing of the Guard

Family-run firms make the leap to institutional fundraising.

In terms of large assets, the real estate investment landscape is dominated by a handful of firms. However, a great many more investment firms manage small funds or are run as a family legacy, encompassing multi-generational family members.

Like all family businesses, family-run investment houses must grapple with the question of how best to develop the next generation of leaders. For those small funds and family offices, the 2008 financial crisis helped answer that question in an unexpected way. It increased the level of oversight and access to information that was demanded by limited partners - just as a new generation of fund managers were ushered in.

Fundraising is an essentially relationship-based endeavor. People often write checks to people they know. In the years before the Great Recession, most small funds and family offices relied on the relatively small circle of high-net-worth family and friends of its senior members. The downturn, however, required that many of these firms cast a wider net.

Successful Road Map

That void represented an opportunity for the firm's sons and daughters to tap their own networks. But unlike the doctor-and-lawyer-laden Rolodexes of their parents, the contact list for the next generation was filled with the names of their business-school classmates, many of whom were now in positions of increasing responsibility at places like J.P. Morgan and CalPERS.

As a result, a wave of institutional money navigated toward small funds, which had previously been below the radar screen. This development coincided with the beginning of a generational shift at many firms and, just as importantly, brought a new set of performance demands accelerating the sophistication of smaller funds.

The individual investors brought in by the parents were satisfied as long as the quarterly checks kept coming, returns were respectable, and they received their K-1s on time. Institutional investors, by contrast, are anything but passive - even with small (for them) $50 million or $100 million bets. Not only do they demand specific reporting requirements, but they may well dictate investment strategy down to the rent roll.

Not surprisingly, some firms managed the demands of this new class of limited partners better than others. The funds that succeeded tended to follow a common road map that stands as a good set of guidelines for small funds looking to step up their game in meeting the expectations of large investors.

Plot your course before the first institutional dollar comes in. Serving large investors is a difference in kind, not in degree, from working with high net-worth individuals. Decide on a plan before an institutional commitment comes in. Provide for the bandwidth and the expertise to manage the new set of expectations. It's critical to have a designated person on the team who knows what you don't know and who can direct the effort of filling in the gaps and committing resources strategically rather than just throwing money at the problem.

Put the platforms in place. Excel isn't going to cut it anymore. Invest in a top-tier reporting platform that can give institutional investors the level of detail they expect. It is important to factor in time for everyone at the firm to move up the learning curve. In the beginning, the firm's members will feel as if they are moving backward. They will be plodding through tasks that they could fly through in Excel. Once each of them reach a base level of competency in the new platform, however, they'll be doing things that would be impossible in a spreadsheet and won't look back.

Know the deals. Working with institutional investors doesn't just mean more thorough reporting. These relationships will change how the firm evaluates transactions and how it makes decisions. More than anything, members of the firm will have to adjust to the reduced autonomy that comes from having an 800-pound gorilla reviewing their decisions.

Cultural Shift

For small funds used to running operations with a free hand, this can be a significant behavioral and cultural shift. The firm is playing on a bigger stage, but it no longer writes all of its own lines. Make sure that the members of the firm are comfortable with what this means and that this cultural change is viewed positively and doesn't affect the team's enthusiasm.

Through all the demands, it's crucial to keep sight of the considerable benefits that working with institutional investors brings - benefits that go beyond capital. Meeting their expectations has provided the impetus for many a fund to strengthen operations and institutionalize a best-practices orientation. And,of course, success with one large investor makes it easier to attract others. More capital, better operations, and a broader network - all of which help not just the firm - but the next generation step into their leadership roles.

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