What Exactly is Small Balance Real Estate?

By Matt Burk

Read SBRE leader Matt Burk’s article defining Small Balance Real Estate and what makes it unique.

What exactly do I mean by “Small Balance Real Estate” (SBRE) and what is a small balance real estate business? I get asked this question a lot. Inasmuch as we sort of created the phrase and only started using it recently, people really haven’t heard of it before. Yet it is one of those terms that seems like it has been around awhile and so they feel like they should know what it means. The reaction is often what you experience when someone recognizes you but has forgotten your name – they don’t quite know whether to fake it or admit it. So, as the person whose name has been forgotten is always best to do, let me re-introduce myself (i.e. the term) and expand a little bit upon its genesis and its meaning, at least as we see it. In our vernacular, a “small balance real estate” business refers to any real estate asset based business model where the size/amount of the equity capital required to do the average deal is less than $2,000,000 and in many or even most cases it is much less than this figure. Often the average deal size might only be $100,000 or $400,000 or some amount well below $1,000,000 which by most institutional standards is looked upon as tiny.

There are literally thousands and thousands of “small balance” real estate based businesses around the United States. Every day and every week we see more and more operators in the SBRE space with some variation or another on a given strategy who make a good living for themselves doing it and at the same time a good return for their investors. When I refer to small balance “real estate”, many people think of the traditional real estate business of simply acquiring property for investment purposes. However, I am also including in my definition ANY business strategy that has real estate as its foundational component, and thus the market (as well as the capital raising requirements) for SBRE businesses is far, far larger. Let me give you some brief examples of what I am talking about. Our definition would include real estate secured lending which in itself has any number of variants including construction loans, rehab or fix and flip loans, small commercial bridge loans, shared appreciation loans, loans to self-directed IRAs, and others. The definition would also include acquisition and disposition of existing real estate secured debt including performing loans, sub-performing loans, and non-performing loans. Even within this micro-niche of the SBRE niche, I have seen people using multiple strategies and channels to produce returns to themselves and their investors. We would also include acquisition, ownership and disposition of tax lien certificates in our definition. And of course, we see multiple versions of direct acquisition of real estate including fix and flip, value add, the buy, fix and hold model, lease to own, and others. Each of these may be executed in multiple sub-asset types including single family, multifamily, retail, office, industrial, mobile homes, mini-storage, and more.

There is no one-size-fits-all definition of small balance real estate. What they all have in common (aside from real estate as the foundational collateral component that provides the risk mitigation that makes well-underwritten deals potentially attractive) is that any and all of these strategies requires ongoing capital to be raised in order to handle any meaningful level of volume. This fact gives rise to the single largest constraint faced by the small balance real estate business owner – access to reliable, timely and cost-effective capital to fund their deals. As I have written about extensively, by far the most appropriate investor type for these SBRE deals is the high net worth individual accredited investor (and the “passive” one at that) and it is a lot of work to consistently, reliably and predictably procure capital from them in order to consistently, reliably and predictably fund your deal flow. This necessarily means that the serious SBRE business person must develop strategies, tactics and tools to do this effectively if he or she wants to grow the business. Those who commit to the development, cultivation and improvement of a strategy and corresponding tactics, tools and skills needed to execute could potentially see their businesses grow more rapidly and get better results than those who have less focus.

My overwhelming experience as both a long-time fund manager raising capital for our own funds as well as advisor, consultant, and mentor to many other fund managers in the space is that this is the hardest part of the business to truly figure out and get right. And it really is never ending. As we prepare to launch our latest fund which will invest in other SBRE funds of all types, I continue to encounter more capital raising lessons even as I write this blog, which of course helps to make the material fresh and meaningful as it is based on real world, ongoing, direct experience in the trenches. For example, I had a lengthy conversation with a placement agent the other day about how our new fund might appear to his institutional sources. As followers of this blog will recall, I am very skeptical of the efficacy and applicability of institutional capital to most SBRE funds (for many reasons). Well, my conversation the other day did nothing to change my view on this topic, even for a fund that will in many ways much better suited to the potential viability of institutional capital in lots of ways. In short, his every comment reinforced my beliefs about how the deeply ingrained institutional dogmatic mindset simply does not lend itself to what is invariably the more entrepreneurial, creative and flexible approach taken by the SBRE businessperson that gives rise to the potentially attractive returns available in the SBRE space in the first place. This is not to say that institutional capital is never available to the SBRE business but rather it is less likely and less well matched than the HNW investor.

The exciting news to my mind is that more and greater opportunities than ever before are coming to the fore as it pertains to raising capital for the earnest and competent SBRE businessperson. The recent passage of the JOBS Act, crowdfunding, the proliferation of self-directed IRAs, and more investor awareness and interest in alternative investments generally are opening up new and innovative ways to access capital. At Fairway, our mission is to facilitate better awareness, understanding and capital flow between investors and fund managers in the SBRE space in as many ways as we can including education (blogs, webinars, the SBRE Investment Summit, etc.), products and services, and ultimately by directly providing capital from our to-be-launched Fund of Funds we are scheduled to launch this summer sometime. In fact, we are working on our capital raising strategy and plan for that fund as we speak which makes me a current practitioner of these ideas as well as teacher of them. As one of my favorite authors Stephen Covey discusses regularly, people learn best when teaching others and that learning is internalized when one is living it. And when a person teaches or shares what they have learned (and are still learning) with others, that person implicitly commits socially to live what they teach. This is certainly true of me which I hope helps to make me a better and more effective teacher as well as brings genuine value and benefit to those reading this material and those who choose to do business with us.

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