Matt discusses the relationship between SBRE entrepreneurs and investors.
Over the past several years, I have been deeply involved with what is now literally well into many hundreds of Small Balance Real Estate (SBRE) entrepreneurs around the United States. During that same time, I have met, spoken and/or engaged with at least that many investors who are active in the SBRE space. These two constituencies form the basis of the SBRE community we are actively building and each side needs the other in order to achieve their respective objectives. As our business model has evolved and matured, I have spent countless hours in the trenches in this industry in both roles of the aisle – entrepreneur and investor – and thus have a genuine appreciation for the issues that deeply impact and affect each. I hope to be able to contribute to bridging the gap between these groups and increasing each group’s understanding of the other to enhance the success of both.
As usual, much of what I am about to say is different than most of what is written and published in the traditional press about investing in real estate, which focuses heavily on institutional real estate investments. In that world, “small balance” means anything less than $250 million and “secondary” markets are Dallas, Seattle, Minneapolis and every other place that isn’t San Francisco, New York or Miami. “Alternative” investing means owning shares in a publicly traded REIT. People who view the world from this vantage point – both investors and sponsors – can’t begin to understand the dynamics that influence and drive SBRE investments or fathom why anyone in their right mind would mess around in this space. Yet, the entrepreneurs and investors who choose to do so exist in vastly greater numbers. And the real operational and practical matters that these people encounter are widely felt but poorly understood, annoying but tolerated, inefficient but endured, because there has not been a voice to intone the messaging about the real issues that face these people. Helping those in both camps better understand and systematically address these issues to improve performance, efficiency, and satisfaction is at the core of our mission. This is not easily done but to us is worth the effort.
SBRE is a capital intensive business. Reliable access to that capital, whether it is equity or debt, is very challenging and highly disparate based on the individual entrepreneur, geography, asset type, strategy, and any number of other factors. The SBRE dilemma, about which I have written extensively, is, stated simply, that every SBRE entrepreneur must continually raise capital for whatever deals it is that he or she pursues and closes. This is not so hard to do in small quantities but becomes increasingly challenging, difficult and time consuming as deal volume grows. Where and how to find this capital is rarely the component of the enterprise that is preferred or attended to with the same enthusiasm or attentiveness as deal acquisition or origination but, if he is to grow, begins to occupy an increasingly larger part of the SBRE entrepreneur’s time, attention, and bandwidth. Traditional lending institutions are bureaucratic and slow (and often not available) and institutional investors (pension funds, endowments, foundations, etc.) are almost totally inaccessible. This portion of the business becomes the bottleneck.
Meanwhile, investors with money who are looking for something that provides the hope of a better return with less volatility than the stock market are attracted to real estate. It is an age old adage that “they don’t make any more land” and widely accepted that real estate is a fundamentally stable asset class. Therefore, many high net worth investors are willing to consider participation in some form or another of real estate asset based investing and these people become the primary source of capital for SBRE entrepreneurs. Once they start looking for investments in this world of SBRE, they find there are actually a huge number of options to place money because of the sheer number of SBRE entrepreneurs around the country seeking capital. But if they do not regularly underwrite real estate deals (and the entrepreneurs who are originating and sponsoring them), they can often get into things and take on risks that they do not truly understand. The deals they do are all over the map and their expectations around the financial reporting of those investments are also often far out of line with the capability of the SBRE entrepreneur, which they only come to learn later.
It is from this basic fount that everything else flows. The motivations of each party can be highly aligned in some respects and directly conflicting in others. The functional capacities of the SBRE entrepreneur in important disciplines of running their business(i.e. accounting, tracking, reporting, legal, tax, etc.) are highly variant, as are the capital structures of individual deals and specific SBRE entrepreneurs. The quality of deal underwriting and asset management is also very different from one to another. Add them all up and predictability of performance, especially over multiple market cycles, is difficult.
These are the fundamental dynamics of SBRE investments. How to effectively deal with these dynamics and improve the overall performance of your SBRE endeavors – whether you are an SBRE entrepreneur or an SBRE investor – will be the focus of my writing and of many of Fairway’s efforts this year. Creating appropriate capital structures, improving alignment of interests, enhancing reporting capabilities, providing greater transparency, simplifying the investment process, cultivating greater understanding between the two constituencies, and much more – these are the things we are attempting to do to help build the community of entrepreneurs and high net worth investors we call SBRE. We believe deeply in this asset class, we believe in the many worthy SBRE entrepreneurs who deserve the opportunity to earn trust from investors, and we believe that investors should educate themselves, understand what they are investing in, and be able to monitor it effectively. It is not an easy or smooth path for sure and there will be potholes and bumps along the way, but we measure our success by the value that we bring to our clients and investors. We hope to be able to provide you with that value in one way or another that suits your needs, and we look forward to working with you this year.