The Benefit of Having Institutional Investors
We often talk about our “investment partners” which range from retail investors to institutional investors. Retail investors include high net worth individuals, celebrities, and others who invest with us as part of their own personal investment portfolios. Institutional investors, on the other hand, pool funds on behalf of others that they then invest in real estate and other financial instruments. Institutional investors include pension funds, mutual funds, insurance companies, hedge funds, endowments, and other large banks and financial institutions.
The world of real estate investment managers is arguably divided into those who have institutional investors and those who do not. This line of demarcation is made in stone.
In this article, we explain why investing alongside institutional investors is so critically important for retail investors.
The Role of Institutional Investors
Unlike retail investors, who may invest $50,000 to $100,000 in a single deal, institutional investors generally invest tens of millions of dollars at a time. In addition to bringing their significant capital resources to a deal, there are several other benefits to having institutional investors:
- Risk Sharing: By partnering with an institutional investor, a sponsor can share the financial risk of a real estate project. This helps mitigate the risk for individual investors and companies and provides a more stable financial foundation for the project.
- Expertise and Resources: Institutional investors have access to a team of professionals with expertise in real estate investment, including analysts, asset managers, and property managers. Whereas a retail investor will largely be hands-off, an institutional investor may be more proactive in helping the sponsor optimize the performance of the real estate investment in order to maximize returns for all.
- Credibility: Having an institutional investor involved in a real estate deal immediately enhances the credibility of the project. Institutional investors are often well-known in the industry and their participation signals to other investors or lenders that the project has been well-vetted and has strong potential for success (more on this below).
Institutional Investors Provide Extreme Scrutiny
Before investing with any sponsor, an institutional investor will undertake robust due diligence on the sponsor, their track record, the company’s financials, and the specific deal in question. Institutional investors have an entire team of people, internally and externally, that are involved in this vetting process including financial advisors, auditors, accountants, and their respective board of directors. This vetting includes:
- Track Record and Expertise: Reviewing the sponsor’s past performance, including successful projects and any failures, to assess their experience and track record in real estate investing. Often, an institutional investor will request audited documents to ensure that the sponsor has not “cherry picked” deals that skew their performance.
- Team and Resources: Due diligence on the sponsors team and resources is critical, including their expertise in real estate, asset management capabilities, market reputation, and access to deal flow.
- Financial Strength: Evaluating the sponsor’s financial strength and stability to ensure they have the resources to execute the proposed investment strategy.
- Alignment of Interests: In addition to financial strength, institutional investors will look to see that the sponsor has sufficient “skin in the game” through their proposed co-investment and other incentives tied to performance.
- Market Knowledge: Assessing the sponsor’s knowledge of the local real estate market and their ability to identify and capitalize on investment opportunities.
- Legal and Regulatory Compliance: Institutional investors want to ensure that the sponsor is in compliance, and will remain so, with all legal and regulatory requirements including any licensing and registration as may be required by the Securities and Exchange Commission.
When a sponsor has an institutional investor as a partner, it signals to retail investors that the sponsor has passed a gauntlet of robust due diligence already. They have passed background checks, reference checks, and other required qualifications. It means that the institutional investors have looked under the hood at a level that most retail investors either do not know how to do or do not have the manpower and capital necessary to do.
To be clear, this does not mean that retail investors do not – or should not – conduct their own due diligence. The reality is that institutional investors simply tend to have more capacity to conduct truly rigorous due diligence, something they must do given the vast sums of money then tend to invest in each deal.
Evaluating Risk Controls
In addition to conducting the due diligence outlined above, institutional investors also gauge the strength of the sponsor’s risk controls. They assess the sponsor’s approach to identifying, assessing, and mitigating risks associated with their deal – or even, their portfolio of deals, if one specific deal is comingled in a fund with other investments.
This evaluation typically looks at looking at the sponsor’s risk management policies and procedures to ensure they have a systematic approach to identifying, assessing, and managing risks. They will also look to understand how the sponsor identifies and categorizes risks associated with their investments, including market risk, financial risk, and operational risks. Then they will look at the sponsor’s strategies for mitigating identified risks, such as diversification, hedging, insurance, or other risk mitigation techniques.
Finally, an institutional investor will review the sponsor’s process for monitoring and reporting on risks, such as their proposed communication and reporting schedule to investors.
Ultimately, it is not just about how good a sponsor’s deals are; any sponsor can find a good deal and make money. But inevitably, sponsors who do enough deals will encounter challenges and those who have strong risk controls in place will be better positioned to weather the storm than those who fly by the seats of their pants.
Multiple Institutional Investors = More Due Diligence
While having a single institutional investor is a good litmus test for the quality of a sponsor, those who have multiple institutional investors – as we do here at Rastegar – have generally undergone even more scrutiny. This is because each individual investment firm has their own series of questions and qualifications that the sponsor must pass.
For example, if we approach XYZ firefighter fund, they might have a series of questions they ask. They might ask to do a background check and they will call references. If we approach XYZ life insurance company, their approach might be more data oriented. An endowment might ask us to come speak in front of their board.
Each time we work with a new institutional investor, our process becomes more refined. We have created a repository of all the information, files, questions, and other data that we will need to be responsive. Our ability to go into these meetings, and share information proactively, helps build momentum for our company and in turn, our deals.
This momentum should not be overlooked. It can be incredibly hard to secure the first institutional investor. The second or third might be equally hard to land. However, once a sponsor has multiple institutional investment partners, it signals to the market that they are high caliber and trustworthy. Having these investment partners at the table helps a sponsor build credibility amongst the others.
Institutional Capital is Patient
Another benefit to having institutional investors is that their capital tends to be patient; they are not looking for a quick score. Instead, they look to invest wisely and relatively “safely” as they are fiduciaries investing on behalf of many others.
Rastegar is well positioned for patient capital. We have proven to be very resilient in our approach. During Covid, for example, while most capital sat on the sidelines afraid of what the markets would do, we closed on over a dozen deals. We tend to be contrarian in that regard; when people are asleep, we are wide awake. When other sponsors are exuberant, we sit things out.
Relying on Audited Financials
The rigor with which institutional investors conduct their due diligence cannot be overstated enough. Not only are they looking at financials in close detail, but they require us to provide audited financials.
At Rastegar, our financials, have been audited by an independent third-party accounting firm. This ensures that an outside firm reviews our financials and provides a report available for any investor to review.
Moreover, retail investors can rest assured knowing that institutional investors are not just verifying our audited work products. In fact, they are conducting their own robust analysis.
Similarly, we are happy to talk with retail investors’ representatives – their financial advisors, accountants, lawyers, wealth managers, and other professionals involved in building their investment portfolios. We realize real estate is usually only a portion (10% to 30%, typically) of a person’s investment portfolio. We can help provide the information so that investors can feel comfortable that an investment with Rastegar is the appropriate puzzle piece to fit within their portfolio. In doing so, we make ourselves available to answer any additional questions or provide any further documentation that would be helpful as they make their investment decisions.
Conclusion
Of course, having an institutional investor (or several, which is often the case) investing alongside you is no guarantee that a deal will perform as expected. However, it signals that there are at least risk controls in place to ensure that investors will not lose money – as they might if they invest in a sponsor who has undergone less rigorous vetting.
It also helps to differentiate sponsors who are skilled “marketers” from those who are truly adept real estate investment professionals. In today’s world, those with large social media presences are often being rewarded as they attract retail investors. While we applaud the marketing prowess of these individuals, investors should be careful to do their own due diligence.
To that end, three questions retail investors should ask are: Does the sponsor have audited financials? Do they use a third-party fund administrator? And do they have institutional capital? If the answer to these three questions is “yes,” then the sponsor deserves your attention. But if the answer to any one of these questions is “no,” retail investors should proceed with extreme caution.
Are you interested in learning more about Rastegar’s investment approach? Contact us today to learn why we continue to be trusted by so many institutional investors and high-net-worth individuals.
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