SBRE Entrepreneurs vs. Institutional Capital – David and Goliath?
One of the most interesting yet frustrating aspects of the real estate investment world to me is the uneasy and challenging relationship between non-institutional and institutional players, between small balance real estate entrepreneurs and banks, between Main Street dealmakers and Wall Street money. In many ways it’s a David and Goliath story. While there is no absolute demarcation line, there is a clear and distinct chasm that exists between the two worlds and most everyone in the industry, regardless of what side they are on, knows which side that is. There is not a lot of middle ground and not many cross the chasm – at least not many small balance real estate entrepreneurs gain enough momentum to work very effectively with or even become “institutional” players themselves (unless they go to work for one). I do notice, interestingly, that many people that work for a Goliath decide to strike out on their own at some point and become a David.
So who is David in our story? That is, what exactly IS a “small balance real estate entrepreneur”? Stated simply, my definition of an SBRE entrepreneur is anyone running a business enterprise whose basic function is to make and manage non-institutional grade and sized investments in one or more real estate asset based strategies that requires the operator of that business to regularly and consistently raise capital in order to make those investments. This definition eliminates a lot of “real estate” people from it by its nature, including real estate agents, mortgage brokers, appraisers, and property managers (at least those in these groups who don’t also raise capital and invest continuously as a business line), as well anyone I would categorize as “institutional” such as large hedge fund managers, REITs, pension funds, banks, and other market participants who play in the more institutional and less entrepreneurial space, and who for the most part just don’t “get” SBRE entrepreneurs and the issues we face.
To clarify even further, let’s put some additional parameters around “Small Balance Real Estate” generally. This is not a hard and fast definition but rather a somewhat loose guideline as there are always folks around the edges that can be considered part of more than one camp. Broadly speaking, SBRE would be considered anything where the average deal is $5,000,000 or less (defined by the amount of capital needing to be raised to close it, which may mean total deal size of much larger than this as true in the case of raising equity capital), and the vast majority of the time, $2,000,000 or less. In fact, in a very large percentage of SBRE businesses, the average deal size is less than $1,000,000 or even $250,000. I know many of what I would consider to be full-fledged SBRE entrepreneurs running SBRE businesses with average deal sizes below $100,000. When it comes to a pooled investment fund, I would loosely define an SBRE fund as one that is below $500,000,000, more frequently below $200,000,000 and the vast majority of the time below $100,000,000. There are many perfectly good, well-run and profitable (for both the investor and our SBRE entrepreneur) funds that have total assets under management (“AUM”) of $10,000,000 or $20,000,000 or $50,000,000.
I have the good fortune of working with a large number of SBRE entrepreneurs – real estate syndicators, fund managers, private lenders, and other small balance real estate players highly active in the SBRE space – all over the United States. To deeply understand their issues, one has to have lived and breathed those very same issues. This is why I get Davids so well – because I am one myself – and have such passion for the challenges we all face when trying to do well what all SBRE entrepreneurs have to do, regardless of specific asset strategy, which is to consistently raise capital from investors. Inevitably during this never-ending quest, almost all Davids have some interaction with, exposure to, have worked for, and/or otherwise have to butt heads with one or more Goliath – a large bank, a private equity firm, an arm of a Wall Street investment bank, a big RIA shop, or some other ostensibly lucrative, limitless, and/or inexpensive source of capital that seemingly might make our lives easier if we could only access it successfully. Unfortunately, for the most part they are just a pain in the ass to deal with and very rarely solve the problem the SBRE entrepreneur is trying to solve. And on the rare instances when they do, they simultaneously present multiple other problems that can be fatal under shifting market conditions and circumstances. Dancing with Goliath is very dangerous.
While these 800 pound gorillas cannot be ignored, they are hard to love or barely even like in most cases because they are having to cope with completely different dynamics than SBRE entrepreneurs. In the case of banks, the ridiculously burdensome regulatory encumbrances make working with them highly aggravating and often fruitless. Even if you can work through the maze of requirements (often of questionable relevance to the actual deal, I might add), it frequently takes months and months to get an answer – too long for most opportunistic situations. When leveraging operating businesses and pooled investment funds (and to some degree although less true for one-off property transactions), the entire enterprise can be essentially at their mercy if you accept their money.
In the case of private equity and Wall Street capital, their actions and behavior often appear to be driven by simple greed and self-interest without any regard for the outcome of the counterparty. If you are doing enough volume to even initiate a dialog, which most SBRE entrepreneurs are not, the one-sidedness of the negotiations and the written agreements are notorious and frankly obnoxious to the sensibilities of anyone who believes in any level of “Win-Win” deal making. It just doesn’t make people feel very good to, as one of my New York acquaintances puts it, “get their face ripped off”.
In the case of consultants, multi-family offices, large RIA shops, and other wealth management firms, they control the investment direction of a great deal of wealth and thus would outwardly seem to be a potentially strong and reliable source of capital. Practically speaking however, they are burdened by a combination of elements that make workable deals with SBRE entrepreneurs very rare. Regulatory requirements, lack of liquidity in non-publicly traded securities, deeply rooted compensation structures and incentives, and other factors make dealing with them a lot like dealing with banks. Not quick, not easy, not fun, mostly futile.
As I was writing this blog, I googled “David vs. Goliath” to learn a little more about the story and found some interesting materials and articles with different interpretations of the meaning. The phrase has come to denote an underdog situation, a contest where a weaker opponent faces a much bigger, stronger adversary. The analogy isn’t perfect, but it does summarize what SBRE entrepreneurs are facing when trying to tap into what would seem to be large sources of capital that they think might simplify their capital raising lives. My overwhelming experience is that this is mostly wasted effort and when it is not, the resultant success fundamentally changes the business model and carries with it risks that expose the entire enterprise or changes it to worker-boss, a situation which most entrepreneurs I have ever met find repulsive.
There are always exceptions to these generalities, of course, but as I encounter more and more people whose circumstances, goals, and realities of building their SBRE enterprise are very similar to my own over the years, I witness the patterns I have personally experienced repeating themselves over and over again. My goal is to help SBRE entrepreneurs recognize those patterns in order to avoid squandering their time and to channel their efforts in areas that are far more likely to comport with the nature of their SBRE business model. The advantage David has is his nimbleness and ability to take advantage of opportunities. He has to have capital to do this, of course, and how he creates a reliable source of it is critical to his success. This is why there always seems to be a Goliath in his life to tempt him into battle. As Malcolm Gladwell said, “the very thing that makes people so intimidating can be the source of their greatest weakness.” So it is with Goliath’s.
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.