SBRE Entrepreneurs and Wall Street – Oil and Water
Not long ago, I was talking to one of our good clients who was telling me about a meeting he had just had with someone from one of the best-known investment banking firms in the country. His Small Balance Real Estate (SBRE) fund was way too small to attract their attention, as are almost all SBRE funds I might add, but he wanted to make an introduction between us and his contact there because he felt our platform might be something in which they’d be interested. As any regular reader of this blog knows, I am extremely bearish on the viability of institutional capital for SBRE entrepreneurs generally and for SBRE fund managers in particular. There are multiple fundamental reasons why Wall Street money simply does not work in the SBRE world (many of which I have written extensively about so I will not repeat them all here) and yet this does not prevent SBRE entrepreneurs from spending lots of time and money attempting to penetrate this virtually impenetrable market. Once in a while it seems as if I find myself feeling compelled to ignore my own advice and once again check it out. And while I no longer will spend any money doing so, I may occasionally agree to a few phone calls to see if somehow the magic pill that every SBRE entrepreneur seeks is more than just the illusion I believe it to be. So after I finished rolling my eyes at the thought of once again talking to a major Wall Street firm about our SBRE model, I agreed to the accept the introduction out of sheer curiosity and decided to have our Managing Director, Darris Cassidy, talk to them.
Darris arranged a call with the contact to whom we were introduced who operates out of their Bay Area office. Much to my surprise, Darris reported back to me that after speaking to the guy for about 30 minutes, he actually seemed enthusiastic about our model and thought that it was something that his clients (ultra-high net worth investors and family offices) were looking for. They wanted out of the stock market due to the volatility, he said, and they wanted more real estate asset based alternative investments. He liked our model and the SBRE community we are creating and felt that it might be an excellent fit for his clients. He said he could not direct any of his clients our way unless/until we were on the firm’s platform and the channel to do that is through their Real Estate Investment Group in New York. OK, here we go, I thought, here comes the rub (there is always a rub). The first guy’s job is to provide you some hope, get you excited, and then, hoping you are so enchanted with the idea of working with a big-name institutional investor, pass you along to the guy who is going to bust your chops and dictate to you how the relationship (assuming there is one) is going to work. But Darris thought he seemed genuine, so we agreed to arrange the next call. So Darris schedules the call with some young hot-shot out of Manhattan, a guy who was probably in his late 20s and I’m sure a very smart, Ivy League educated individual (they only hire the best, of course!). The call was scheduled for 45 minutes, ended up lasting about 10, and, unfortunately but unsurprisingly, reconfirmed pretty much every conclusion I have drawn about the impracticalness of institutional capital for SBRE entrepreneurs. Here are the paraphrased highlights.
He explained that they are looking for the top fund managers in the nation (whatever that means to them) and can invest in funds, but more often they prefer sidecars or co-invests where they basically form a fund or entity specifically for their investors at terms dictated to the SBRE entrepreneur by them (conclusion #1). Darris briefly explained our background, our history, and our current business model and funds. The guy asked some questions around the type of assets, the underlying fund managers, geography, etc. – some typical softball questions in an attempt to be somewhat polite since they are only a few minutes into the call. He found it fascinating and unheard of that we have an open-ended fund with the asset model we have (conclusion #2) and Darris couldn’t quite tell if he thought this was cool and different or just plain idiotic since it was something he hadn’t seen and it didn’t comport with his notion of how institutional funds are structured. He then abruptly said there doesn’t seem to be any way for us to work together and stated that the only way to work together would be if we ever came across larger deals that “we couldn’t handle”. We could instead introduce those deals to them (lucky us!), but only if they were a minimum of $15M and really anything below $25M was not something in which they would be interested (conclusion #3). Darris asked him if they might consider investing in Fund VII and his response was an emphatic “no”. Darris asked if he would have a different response if/when Fund VII was over $100M in AUM and he said “no” again. When pressed as to why, his response was that it is because his firm’s investors put money with them to execute a similar strategy to ours (i.e. finding other managers and co-invest opportunities), only their deals “are bigger and better” than ours. Then Darris said, “Well, I guess there isn’t any way to work together”, a notion the guy confirmed (conclusion #4) and quick but awkward good-byes were exchanged.
None of this brief encounter surprises me one bit and in fact confirms all that I have learned over the years about how institutional money operates. In essence, to obtain their capital, unless you are a multi-hundred million dollar fund, you pretty much work for them. For most SBRE entrepreneurs, the notion of working for someone else just doesn’t get you excited. Institutional capital demands 1) control, 2) conformity, 3) large dollar amounts and 4) more control. I don’t blame them for wanting these things and I understand why they want them, but this combination of requirements makes it a bad fit for the vast majority of SBRE entrepreneurs. Not because we SBRE entrepreneurs do not want to provide some oversight, transparency and appropriate governance, but because the size, the structure and the strings attached just do not match up well with the reality of operating a small balance real estate enterprise. This does not mean that institutional capital is not available to SBRE entrepreneurs in some circumstances and for some asset models. It does mean that when it is available, it is almost always in the form of a managed account, a sidecar or co-invest, in larger amounts only, and on terms that are largely dictated by them.
We are increasingly finding ways to attempt to bridge this gap, as in the case of creating pooled investment funds for SBRE entrepreneurs for the purpose of bringing GP co-invest capital alongside institutional capital to do individual deals. This works in some situations and not in others, but is at least a viable option for SBRE entrepreneurs doing fairly sizable value-add real estate acquisitions. In my forthcoming book, Capital Attraction, the Small Balance Real Estate Entrepreneurs Essential Guide to Raising Capital, which will be available in mid-April, I discuss these and other similar topics in much greater detail. How to consistently and reliably capitalize your SBRE business is one of the most difficult aspects of your business for most small balance real estate entrepreneurs and one for which we are committed to providing the most comprehensive and compelling set of tools available anywhere. For most of you, the simple fact is that it will NOT be institutional capital in the early days and probably never will. Once you accept this truth and begin to work within the unwritten rules of how capital can actually be raised, you save yourself time, money, and frustration. After all these years, I can now laugh about encounters like the one described above and write a tongue-in-cheek article like this sharing my experiences in the hopes that I can save others much of these precious resources.
Matt Burk is founder and CEO of Fairway America, LLC, and SBREfunds.com, and Chief Investment Officer of Fairway’s two proprietary nationwide small balance real estate (SBRE) asset based pooled investment funds, Fairway America Fund VI, LLC, and Fairway America Fund VII LP. Fairway is the nation’s premier consulting, advisory, and investment firm in the SBRE private pooled investment fund space, providing a full spectrum of practical, real world products and services (including capital) needed for true success for SBRE entrepreneurs all over the U.S. Matt is a highly regarded adviser, consultant, and mentor to dozens of SBRE fund managers and author of a widely read blog followed by serious SBRE entrepreneurs and investors. For over 20 years, Matt has led Fairway’s deal underwriting as well as capital raising efforts in Fairway’s seven proprietary funds and individual trust deed investments, resulting in more than $250,000,000 in capital raised from accredited investors through more than 1,000 SBRE deals. He is currently working on multiple SBRE fund consulting engagements nationwide, authoring a book on how to raise capital for and effectively manage pooled investment funds, and dedicating his efforts to create greater awareness and drive more capital to the many high caliber and deserving SBRE entrepreneurs around the U.S.