Joint venture equity is available, but it remains cautious. That continues to be the feedback provided by MHN’s sources. There is plenty of equity that has migrated from core to the higher-yielding value-added sector, driven by the low-interest-rate environment. However, it may still be a challenge for developers who are looking to match with the most appropriate joint venture partners.
The universe of equity providers has remained fairly constant over the past few years, and there does not seem to be a shortage of investment capital. According to Preqin, as far as private equity that invests in U.S. real estate, 88 funds (funds of at least $10 million each) were created, and $35.4 billion in aggregate commitment was raised in 2011. In 2012 to date, 46 funds and $14.5 billion of private equity have been raised. And since 2008, a total of $14.5 billion has been raised, according to the data from Preqin.
“In general, “there is a tremendous amount of private equity,” observes James Tramuto, managing director of Jones Lang LaSalle. However, there may be a difference in the level of interest for new construction versus acquisition and turnarounds. According to Tramuto, equity for multifamily new developments is still highly selective and very difficult to access.
“Capital also seems to be biased towards investing in urban infill,” says Tramuto. “Very little new money [is] available for traditional suburban garden developments.”
On the other hand, a deep and plentiful capital market is available for investing in value-added apartment transactions involving acquisitions and/or turnarounds. In this category of investments, institutions are “flocking to [the multifamily] asset class,” says Tramuto.
The types of joint venture equity investors, targeting investments from core to opportunistic, have remained pretty constant. They range from high-net-worth individuals to private equity and hedge funds to institutional investors.
Brian Ward, chief investment officer of TCG Capital Markets LLP, advises sponsors seeking equity investments to try to “marry” their investment styles with the capital source as much as possible. For example, a sponsor used to accessing capital from high-net-worth friends and family may not fit as well with large Wall Street private equity players. And an operator with a long-term investment horizon would be poorly matched with a private equity fund that requires short-term investments to meet yield and asset allocation requirements. After matters of style are considered, the sponsor should then try to match property age, location, risks, investment terms and required capital, Ward advises.
In the middle-market property segment, investors in the “high-net-worth individuals” category tend to be more flexible and patient with their capital,” points out Ward. The high-net-worth investors also have a greater tendency to look for current yields and are focused more on cash-on-cash returns rather than IRR, compared to the private equity funds, notes Mitchell Kiffe, senior managing director and co-head of national production for CBRE Capital Markets.
Institutional investors, such as pension advisors, investment managers or life insurance companies, normally have a minimum equity investment requirement of at least $7 million to $10 million at leverages of 65 to 70 percent, reports Kiffe. And the preferred investment hold for many institutions seems to be for about five to seven years.
According to Kiffe more of CBRE’s institutional clients are expressing a willingness to migrate from the core investment sphere to opportunistic plays in their search for yields in a low-interest rate environment. Nevertheless, it’s still a challenge raising equity from institutions for new development, even when the sponsor is experienced.
Tramuto sees three major buckets of institutional equity capital for acquisitions and renovations of existing apartments. There are closed-end funds managed by fund advisors such as Angelo, Gordon, Heitman and Long Wharf Investors. Entities such as these are seeking three to five year holds and mid- to high-teens type of returns, and they almost always take place besides the operating partner through a joint venture.
A second type of investors are the life insurance companies who may also engage in direct investments, in addition to investing in joint ventures. They have a hold period of five to seven years, and return expectations are in the mid-teens. A third group of institutional investors are the separate account pension advisors. Entities such as JP Morgan, LaSalle Investment Management and Invesco manage for private and public pension funds. Rather than investing in funds, pensions also tend to find individual deals, and they are pretty prevalent investors in the value-added and core-plus segments of the market.
Joint venture arrangements are typically structured with a preferred return paid by the developer to the joint venture partner followed by promotes, or profit-sharing compensation, at the back end accruing to the developer once certain return benchmarks have been achieved for the investor. These subsequent distributions to the sponsor are typically “waterfall” in nature—increasing in proportion to the amount of the profits. Generally, the higher the amount of value-add and overall risk of the project, the higher the percentage of the developer’s promote. “If you have a low risk project in an urban infill without much value-add, the investor will say, ‘If I can do this on my own, why would I need to pay to promote someone to do it for me?’” Tramuto points out.
Equity investors today are tending to derive more of their total returns on the front end in the form of current preferred returns rather than on the back end in the form of residuals, says Ward. The joint venture partners are desiring to lessen their risk, especially in light of the “frothiness” of markets or possibility for cap rate increases in the future. Ward also cautions that sponsors often fall behind in paying the preferred return to their equity sources, and as a result, the amount owed can eat into their profit participation at the back end.
It may be advantageous to raise equity funds rather than one-off deals, as that builds a better track record. Kiffe says that the sponsor must have experience owning and operating real estate. And if they have not raised funds before, it may be very challenging for them to reach “the finish line” in terms of raising equity.
Ward notes that sponsors sometimes may want to stay in the deal longer than the equity provider. In this regard, there may be a misalignment of expectations between the two parties. The sponsors may derive asset or property management fees from the deal, whereas the equity providers may want to keep their investments locked into the real estate investment since yields on alternative investment are generally low today. Sponsors may therefore want to write into the contracts the ability to force a sale of the property. “The investment capital and the sponsor need to be aligned not only on the buy side, but also on the sell side,” notes Ward.