Fund Business Model - Is it too late?

Hi everyone,

I hope you are doing well despite the pandemic. I'm a first-year analyst in a well-known shop and look forward to pursuing an MBA. My current supervisor benefits from a great one and so I exchanged with him about post-MBA goals. I told him that in the long-term, I would like to raise my own funds and make value add/opportunistic acquisitions. He told me that this type of business model was kinda outdated, as all the major players are already in place. He also told me that this is a classic story (analyst who wants to go out on his own and raise funds after an MBA) and that AdCom will rather encourage someone with a more entrepreneurial vision (proptech, fintech, bringing a new vision of the business).

Is anybody have any thoughts about this? I must admit that I'm kinda lost right now.

Thank you.

 
Most Helpful

Depends what you mean by "value add".  For the last five or six years I hear people throw around that term and what they mean is "I'm the third person in 5 years to buy some garden style apartments in the south/southwest, I'm gonna throw new countertops and appliances in and jack rents by 20%!"

That model is dead.  As the above might imply, people have picked those kinds of assets over a bunch and are/were just playing a game of musical chairs to see who gets saddled with a property they overpaid for and can't find a new buyer with the same business plan.  That doesn't mean true value add is dead.  Maybe it involves affordability and bringing in tax abatements, or Section 8.  Maybe it means working on smaller assets and aggregating.  It's tough to compete on big deals with larger funds, sure, but there is always a niche if you have exceptional local intel or specialized knowledge.  

That being said, raising money at scale is tough and requires a lot of reporting and back office, so your supervisor isn't wrong that there are significant hurdles to that business model.

 
Analyst 1 in RE - Comm

 this is a classic story (analyst who wants to go out on his own and raise funds after an MBA) and that AdCom will rather encourage someone with a more entrepreneurial vision (proptech, fintech, bringing a new vision of the business).

So, yeah, I pretty much agree with this person giving you advice. You are proposing a "me too" business, as in you are essentially proposing to do what everyone else does. The reality is that real estate is getting "institutionalized" quickly, but still lags maybe 20-30 years beyond mainline finance (like stocks/bonds/banking businesses) due to the unique nature of the assets (not easily tradeable or commoditzable). BUT, the real estate investment management industry IS subject to those same forces even if the assets themselves are not, and technology is closing that gap.

So what does that mean.... just think what has happened to traditional stock brokers, financial advisors, and actively managed mutual funds due to the rise of "discount" brokers, index mutual funds, ETFs, robo-advisors, etc. Just in case this isn't clear, those "traditional" services are getting crushed like cabs vs. Uber. Are they "out of business"? NO, but fees are coming down as is profitability.... and thus one smart/defensive move is for consolidation. 

My guess is is that in the next 10-20 years (maybe faster), I'd expect a lot of consolidation in the real estate investment management industry, the true investors (aka the "LPs") are demanding lower fees; they have little desire to let places like Blackstone make the money they did last decade, and they know they have the muscle to negotiate (and are actively doing so within fund investments and via SMAs). The biggest "LPs" are also deepening their internal real estate management teams (like CalPERS). 

So, yeah, you are kinda proposing starting a taxi-cab company in the era of Uber. Your expenses and start-up costs will be more difficult to justify in the face of fee compression unless you can really show why you will outperform competitors. Your boss is essentially asking, "why would I invest with you as a start-up, when I can get better service/lower fees with an established offering?".... and that is exactly the right question you should ask. 

A "new frontier" for small operators is likely from the crowdfunding field which is very new and looks to serve very small ticket sizes (like avg $25-50k), the big groups are raising their minimums up to $50 million, so there is probably some "missing middle" for smaller investors. Personally, I think the "go your own" route only makes sense if you are really good at raising money and have it lined up, there is a place for this, but just remember who you will competing with to buy property... as in, how much can you pay and sustain vs. them. I have ZERO interest in going out "on my own" in such a format, if I ever did, it was because I was part of or came up with seriously enticing entrepreneurial idea or saw a wide-open market opportunity (I can 100% promise you, it's not classic value-add/opportunistic). 

Final point, your boss may also be opining on the concept of a 1st year planning on "going out on their own" in just a general snarky way. In fairness, it looks easy at your stage as you are not really fully familiar or know all that is involved, the more experienced you get, the more you figure out why so many people very happily stay employed at large and small firms vs. going out independently. I never criticize or comment on the "go out on my own" statements on WSO because I thought or said the same thing when I was in my 20s, now that I am late 30s, I feel quite a bit differently. 

I think what many people are really saying (I won't judge the OP on their intentions, I don't know), is they want to have FU money. That makes sense, and the do own deal path seems the most direct/fastest route (and clearly it can be IF successful). Having FU money and doing deal on one's own are two very very different things. I think when looking down the line of a decade or more to actually doing something like starting a business, it is easy to compress the route and destination into one concept. When actually looking at the route/deals, I think most see it's far from guaranteed or the same thing. Just my personal view anyway!  

 

All your points are very valid! I am just confused on whether you are talking about institutional money with class A or even class B products. Coming from someone who hasn’t worked in the real world, I am wondering are you this pessimistic about local developers & owner/operators in cities?

 

So, to be clear... my comments are very focused upon the "capital" side of the business, i.e. the raising and deploying of cash into equity and debt investments. 

The actual "on the ground" part of real estate is far more difficult to commoditize and their will remain plenty of space and need for the local owner/operators. Even more true for the development business which faces steeper regulatory issues in almost every city large and small. Still, the flood of capital from all sources will have the effect of making "institutional assets" more valuable (i.e. low cap rates/low yields/low req. IRR/etc.) as there will be more bidders of all types (this is not new, been steadily rising for decades). 

Thus, the one who can transform a non-institutional asset into an investment grade/institutional asset can stand to make a good return. In fact, there are probably increasing opportunities as more and more types of assets (and types of markets equally) will qualify as "investment grade" as a result of more capital all in competition. BTW, you can watch this happen real time in the stock market, amazing what can get a billion dollar valuation these days! 

Still, more capital for debt and equity will spur more competition on the local market side. More cash funded buyers will make it more difficult for "newcomers" to get going who aren't as well capitalized. This is increasingly true for Class B/C assets and has been true for Class A for a long while. 

I mean, just being able to list property of any kind on sites like loopnet has made a more global market for even really small/shitty assets in small towns a reality. This was essentially impossible 20 years ago, yet today, people come in and buy small strip centers, RV parks, warehouses in small towns everywhere from all over the place and some don't even bother to visit the damn thing! Same for loans, lenders making loans nationwide where 25 years ago lending tended to be very regional (regulators intentionally forced this change in the 90s after the late 80s S&L crisis). 

In short, even the small local owners/developers are being backed by large PE funds, pension funds, debt funds, or even these new crowdsourcing platforms. So they are starting to act like big institutions and bid up prices as well. 

Bottom line, its wrong to see this as "pessimistic", there are tons of interesting opportunities, jobs, deals, and other ventures as a result. Just thinking that doing deals like they did in the 80s or 2010's in the 2020s/2030s is going to happen is not realistic. You should talk to some of the salty old people doing syndication deals in the 70s/early 80s, they were literally put of of business by Regan's '86 tax reform deal; real estate was declared DEAD. In reality, it just gave rise to the REITs and eventually private equity funds to having better power over individual/HNW investors. 

There will continue to be these capital "rotations", the next one I see is away from private equity funds and pension funds towards funds that are directly accessible by individual investors at all wealth levels. This is what the crowdsourcing platforms are testing, the non-traded REITs figured out, and large institutions are thinking of and also experimenting with. Whoever figures out how to get direct private real estate into 401ks/IRAs will be a king! 

Personally, I see these changes as exciting, not scary. Just don't fool yourself in to thinking it will be easy, that is probably the true WSO fallacy of "going out on your own". 

 

Excellent post, as always. I agree that to jump into a saturated market without a unique offering would be misguided at best. 

redever

In fairness, it looks easy at your stage as you are not really fully familiar or know all that is involved, the more experienced you get, the more you figure out why so many people very happily stay employed at large and small firms vs. going out independently. I never criticize or comment on the "go out on my own" statements on WSO because I thought or said the same thing when I was in my 20s, now that I am late 30s, I feel quite a bit differently.

To offer a general counterpoint to this, I've seen many smart, otherwise successful people not go out on their own due to unfounded fears (most common being something like back-office / administrative / marketing, which is sad because each year those become more easily abstracted away by technology). The two most common founded fears I've seen are lack of energy to start something new and having already been promoted to the edge of their competencies.

“Doesn't really mean shit plebby boi. LMK when you're pulling thiccboi cheques.“ — @m_1
 

I would agree on the fears being a major holdback, but notwithstanding fears (unfounded and founded), the level and form of compensation offered to senior people in this industry really makes it difficult to say that leaving to strike out on one's own is really the smartest move on a risk adjusted basis. 

I mean, if you really have the skills/abilities to be successful in a new venture, you should (very in theory) be able to earn 7 or even 8 figures between base + bonus + long-term comp (which often includes equity or stock options). You can get these earnings without signing personally on notes or pledging any of your own liquid assets (most of the time, some do borrow at personal liability to make co-investments). If things blow up, you liability generally ends at zero payout unless you really were engaged in fraud or extreme negligence. Plus, you have the optionality of leaving for a better offer or joining/starting an entrepreneurial venture; all with very little reputation risk, if any. 

Once you are tied to investors or loans and deals as part of a new venture you control, you can no longer "walk away" without significant reputational risk, loss of capital, or even bankruptcy. Plus you take all the exposure of legal risks of partnership fights, employee issues, and damn well everything else. Sure there could be massive upside, but on a pure risk-adjusted basis, it's easy to see why its not really worth it for people very successful already.

I think this is why so many of the "startup stories" involve people fired from jobs, leaving companies that failed, or were just "rejected" from the top tier space and literally starting out on their own was only route to the top. Once you really "make it" in the institutional world, I don't know if the motivation/justification exists anymore. 

Personally, I'm not at that "top" level yet, but when I see those people in my own firm and others around town, I think they would be crazy to jump to their own deal compared to current opportunities or what they could be paid by a competitor (and very few do so it seems). 

 

FWIW, assuming the applicants meet a baseline competency, it behooves AdComs to err on the side of the more entrepreneurial applicants. A moonshot success among even an incredibly small number of alumni provides for a potential massive windfall donation back to the school that exceeds many smaller donations from salaried alumni. Remember what business b-schools are really in.

“Doesn't really mean shit plebby boi. LMK when you're pulling thiccboi cheques.“ — @m_1
 

I think you are giving admissions people way too much credit, they really do not know how to evaluate the "proposals" in peoples' essays. The read for passion, structure, and competence. BUT a well articulated entrepreneurial vision is going to read wayyyy more interesting than some "I want to go buy older apartments and reposition them for a 12% IRR" type speech. It's just one is really interesting and the other is boring AF to someone not in the real estate industry. Being interesting is just more likely to get someone a positive nod if on the line elsewhere, just human nature. I really don't think admissions folks (who are all education degree type people generally) are worried about who will be successful and thus donate, wayyyy above their pay grade or area of concern. 

 

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“Doesn't really mean shit plebby boi. LMK when you're pulling thiccboi cheques.“ — @m_1

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