Introduction to Private Real Estate 🧵
Thoughts presented in the context of a typical large real estate franchise.
Contributors:
@blader
@capatli
@DrastikThomas
@echodot126
@morizmartiner
@Rob_Slh
@SigeVinken
@Will_DeCotiis
@KiwiPMI
CC @INArteCarloDoss
Thoughts presented in the context of a typical large real estate franchise.
Contributors:
@blader
@capatli
@DrastikThomas
@echodot126
@morizmartiner
@Rob_Slh
@SigeVinken
@Will_DeCotiis
@KiwiPMI
CC @INArteCarloDoss
For private capital fund background, this thread should be read in concert with
PE:
VC:
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PE:
VC:
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Disclaimer: Given legal & acct. complexity, thread omits investment structures that lower / reduce tax, although they are meaningful drivers of total return.
Consequently, FIRPTA, Luxembourg SARLs, Cayman, Guernsey, blocking vehicles, etc. are omitted from the discussion.
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Consequently, FIRPTA, Luxembourg SARLs, Cayman, Guernsey, blocking vehicles, etc. are omitted from the discussion.
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Fund Format: Basic Form #1:
1. Core Plus: 60 - 80 bps mmgt fee possibly modest carry depending on product.
2. Development - typically closer to the 2% mmgt fee & 20% carry PE format.
3. Hotels - often corporate formats but can be private capital as well.
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1. Core Plus: 60 - 80 bps mmgt fee possibly modest carry depending on product.
2. Development - typically closer to the 2% mmgt fee & 20% carry PE format.
3. Hotels - often corporate formats but can be private capital as well.
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Fund Format: Basic Form #2:
4. Financial - Mortgage Investment Corps (MICs) - spread over lending rate.
5. Other PE: Distressed/opportunistic e.g., Apollo funds buying RE debt.
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4. Financial - Mortgage Investment Corps (MICs) - spread over lending rate.
5. Other PE: Distressed/opportunistic e.g., Apollo funds buying RE debt.
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Core Plus Typical Segments #1:
1. Office - various classes A, B etc,
2. Residential - multifamily, seniors, student housing [including small and temporary apartments]
3. Industrial [not typically Core] - warehouses, factories, light industrial
4. Logistics
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1. Office - various classes A, B etc,
2. Residential - multifamily, seniors, student housing [including small and temporary apartments]
3. Industrial [not typically Core] - warehouses, factories, light industrial
4. Logistics
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Core Plus Typical Segments #2:
5. Commercial - (stand alone) retail, supermarkets, shopping centres
6. Healthcare RE
7. Hospitality: hotels or restaurants/pubs (brewer’s estates)
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5. Commercial - (stand alone) retail, supermarkets, shopping centres
6. Healthcare RE
7. Hospitality: hotels or restaurants/pubs (brewer’s estates)
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Development - 2 kinds:
1. Greenfield - redeveloping vacant land.
2. Brownfield - redevelopment of existing facilities i.e., warehouse condo conversion, adding additional buildings on to existing properties.
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1. Greenfield - redeveloping vacant land.
2. Brownfield - redevelopment of existing facilities i.e., warehouse condo conversion, adding additional buildings on to existing properties.
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Hotels - a hybrid owner operator format i.e. Mandarin Oriental (Jardine Matheson), Starwood Hotel & Resorts, Four Seasons (Bill Gates & Al-Waleed bin Talal).
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Financial: MICs provide the debt financing for development projects.
Funds frequently aggregate from multiple Mom & Pop investors. Sometimes funded via a single, evergreen fund but often across multiple fund formats.
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Funds frequently aggregate from multiple Mom & Pop investors. Sometimes funded via a single, evergreen fund but often across multiple fund formats.
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Operator Strategies #1:
Target geography and/or sector with “macro thematic” i.e., growing demographics, industry change (e.g. from high street to logistics based on growth of B2C online trade), interest rates & and long term RE cycles.
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Target geography and/or sector with “macro thematic” i.e., growing demographics, industry change (e.g. from high street to logistics based on growth of B2C online trade), interest rates & and long term RE cycles.
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Operator Strategies #2:
Transaction Returns (“T.R.”) vs Operational Returns (“O.R.”).
Former is typically faster with higher IRRs as O.R. require execution & time.
Inherent trade-off between T.R. & O.R. is valuation, investment capex and cash flow.
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Transaction Returns (“T.R.”) vs Operational Returns (“O.R.”).
Former is typically faster with higher IRRs as O.R. require execution & time.
Inherent trade-off between T.R. & O.R. is valuation, investment capex and cash flow.
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T.R. Upside #1
1. Buy cheap (non-core), improvements drive valuation (vacancy, lease terms, tenant quality etc).
2. Convert to Core.
3. (Re)finance at cheaper rates & better loan terms.
4. Accumulate properties in sizes & type market wants, drives premium / removes.
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1. Buy cheap (non-core), improvements drive valuation (vacancy, lease terms, tenant quality etc).
2. Convert to Core.
3. (Re)finance at cheaper rates & better loan terms.
4. Accumulate properties in sizes & type market wants, drives premium / removes.
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T.R. Upside #2
discount from portfolio.
5. Bargains due to maturity of other funds or orphan assets
6. Optimising corporate structure (cash traps, tax optimisation etc).
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discount from portfolio.
5. Bargains due to maturity of other funds or orphan assets
6. Optimising corporate structure (cash traps, tax optimisation etc).
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O.R. Upside #1
1. Maintaining high tenant quality, low turnover; above market rents
2. Low rent loss
3. Long lease terms (>5 years drives full valuation)
4. Low vacancy
5. Tenant improvements vs. Rent levels (chose trade off to optimise valuation)
6. Efficient, economical.
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1. Maintaining high tenant quality, low turnover; above market rents
2. Low rent loss
3. Long lease terms (>5 years drives full valuation)
4. Low vacancy
5. Tenant improvements vs. Rent levels (chose trade off to optimise valuation)
6. Efficient, economical.
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O.R. Upside #2
7. Capex & OpEx - technical aspects should not be underestimated
8. Regulatory compliance - health & safety, fire, tenant rights, energy efficiency etc.)
9. High quality low cost real time controlling and reporting functions.
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7. Capex & OpEx - technical aspects should not be underestimated
8. Regulatory compliance - health & safety, fire, tenant rights, energy efficiency etc.)
9. High quality low cost real time controlling and reporting functions.
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Development #1 (“all gains & risks generated through building rights)
1. Value add due to skilled planning, superior access to planning officers & longevity of that relationship, political expertise & affordable housing crises.
2. Superior designs.
3. Change of use
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1. Value add due to skilled planning, superior access to planning officers & longevity of that relationship, political expertise & affordable housing crises.
2. Superior designs.
3. Change of use
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Development #2
through conversion of existing building.
4. Target audience differentiation i.e., marketing high end properties to foreigners.
5. Anticipating demand (demographics matters, especially predicting migration flows & other population drivers.
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through conversion of existing building.
4. Target audience differentiation i.e., marketing high end properties to foreigners.
5. Anticipating demand (demographics matters, especially predicting migration flows & other population drivers.
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Development #3
6. Creating demand i.e., Monte Carlo, Sloane Street, Dubai, Andermatt, etc.
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6. Creating demand i.e., Monte Carlo, Sloane Street, Dubai, Andermatt, etc.
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Investors:
1. Core Plus - pension funds, insurance, & co-mingled public & private funds.
2. Development - often private capital sponsors entrepreneurial firms
3. Hotels & Resorts - corporate & institutional
4. MICs - largely retail for most of the smaller programs.
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1. Core Plus - pension funds, insurance, & co-mingled public & private funds.
2. Development - often private capital sponsors entrepreneurial firms
3. Hotels & Resorts - corporate & institutional
4. MICs - largely retail for most of the smaller programs.
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Holding Period:
1. Core Plus 5 - 20yrs
2. Development: i) warehoused capital (Cost plus) ii) speculative / built for end client.
3. Hotels +10yrs. New owners often add value through re-development.
4. MICs - subject to structure (see above) but 1 - 5yrs is typical.
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1. Core Plus 5 - 20yrs
2. Development: i) warehoused capital (Cost plus) ii) speculative / built for end client.
3. Hotels +10yrs. New owners often add value through re-development.
4. MICs - subject to structure (see above) but 1 - 5yrs is typical.
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Return Types:
1. Rental Income: Payments by tenants for the use or occupation of property.
2. Appreciation: Change in market value of the property.
3. Tax: Depreciation of property drives income-tax write-offs.
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1. Rental Income: Payments by tenants for the use or occupation of property.
2. Appreciation: Change in market value of the property.
3. Tax: Depreciation of property drives income-tax write-offs.
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Industry Segments:
1. Asset MMGT: Hire/fire property mmgt, renos/upgrades, refinancing, marketing/sale of property
2. Property MMGT: Rent collection, payment of ordinary expenses, maintenance, servicing tenants, accounting services.
3. Servicing: cleaning, maintenance.
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1. Asset MMGT: Hire/fire property mmgt, renos/upgrades, refinancing, marketing/sale of property
2. Property MMGT: Rent collection, payment of ordinary expenses, maintenance, servicing tenants, accounting services.
3. Servicing: cleaning, maintenance.
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Leverage #1
Typical leverage: LTV 35 - 40% or more conventionally 4-6x Debt/ EBITDA.
H/T @kitty_sivkov_i
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Typical leverage: LTV 35 - 40% or more conventionally 4-6x Debt/ EBITDA.
H/T @kitty_sivkov_i
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Leverage #2 (Benefits & Costs)
Advantage: levered returns generated by: rent residual, debt supported refis, capital gains & operational improvements.
Disadvantage: Default, re-possession & damaged relationship with bankers.
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Advantage: levered returns generated by: rent residual, debt supported refis, capital gains & operational improvements.
Disadvantage: Default, re-possession & damaged relationship with bankers.
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Leverage #3.1 (Syndication, Securitization & Tranching)
Syndication: Banks pool capital to finance a borrower to diversify loan risk.
Securitization: Loans are pooled and packaged into security or bond (e.g. MBS, CMBS).
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Syndication: Banks pool capital to finance a borrower to diversify loan risk.
Securitization: Loans are pooled and packaged into security or bond (e.g. MBS, CMBS).
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Leverage #3.2 (Syndication, Securitization & Tranching)
Tranching: Pools of securities are packaged into a waterfall of risk/return based on maturity, credit rating, etc. (e.g. senior, mezz or equity CDO)
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Tranching: Pools of securities are packaged into a waterfall of risk/return based on maturity, credit rating, etc. (e.g. senior, mezz or equity CDO)
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Family Office (“F.O”.) / Non-Development Syndication Fees #1:
Large Funds:
1. Typically 2% asset management fee and 20% carried interest fee.
2. Carried interest tied to a preferred return in 8-10% range.
3. Some AM fee based on called/invested capital.
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Large Funds:
1. Typically 2% asset management fee and 20% carried interest fee.
2. Carried interest tied to a preferred return in 8-10% range.
3. Some AM fee based on called/invested capital.
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F.O / Non-Development Syndication Fees #2
Private Deals/Syndications:
1. More variability.
2. AM fee can range from 1-2% and carried interest up to 50%.
3. Tiers for carry - higher return results in bigger split.
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Private Deals/Syndications:
1. More variability.
2. AM fee can range from 1-2% and carried interest up to 50%.
3. Tiers for carry - higher return results in bigger split.
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F.O. Leverage Preferred Equity #1:
1. RE operators use mezz debt structured as preferred equity.
2. Avoids covenant calculations from senior or construction loan.
3. Preferred equity secured above common
Created up to 90% LTC to magnify return for common shareholder.
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1. RE operators use mezz debt structured as preferred equity.
2. Avoids covenant calculations from senior or construction loan.
3. Preferred equity secured above common
Created up to 90% LTC to magnify return for common shareholder.
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F.O. Leverage Preferred Equity #2:
1. In current environment, most common equity wiped out
2. Preferred equity becomes owner
3. Drives debt paydown & work with senior lender at maturity
4. May delay senior default
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1. In current environment, most common equity wiped out
2. Preferred equity becomes owner
3. Drives debt paydown & work with senior lender at maturity
4. May delay senior default
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F.O. Portfolio Strategy
1. Effective due to PE fund and REIT dynamics.
2. Looking for deals worth at least $100 million.
3. Fund incentivized to invest dollars.
4. REITs focus on maintaining dividend.
5. Smaller and lower-tiered assets benefit from valuation lift.
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1. Effective due to PE fund and REIT dynamics.
2. Looking for deals worth at least $100 million.
3. Fund incentivized to invest dollars.
4. REITs focus on maintaining dividend.
5. Smaller and lower-tiered assets benefit from valuation lift.
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Public vs Private Valuation Disconnect:
Key Drivers:
1. Reporting lag.
2. Private RE is illiquid.
3. Price change inputs (IRs, econ. growth, other macro)
not immediately reflected.
4. Private is value-based & past transactions. Public is priced off comparable comps.
/End
Key Drivers:
1. Reporting lag.
2. Private RE is illiquid.
3. Price change inputs (IRs, econ. growth, other macro)
not immediately reflected.
4. Private is value-based & past transactions. Public is priced off comparable comps.
/End
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