There was a question in the forums a few weeks ago about what life is like working at operating partners for Private Equity firms. My current firm specializes in land development and we often do JV’s with real estate private equity firms. In these deals they provide the majority of the capital while we serve as an operator and manage the asset and develop and sell the land. I have worked here for almost a year and I thought I could shed some life on what life is like at a real estate operating partner by listing four things I’ve learned this year about being an operator.
1) You spend a lot of your time attempting to convince capital partners to do deals with you. A lot of my time is spent modeling potential acquisitions but once those deals are modeled and we have a firm grasp on it, the majority of the time is spent talking with capital providers and attempting to convince them that the deal is a winner. We spend a considerable amount of time walking our potential partners through the model and explaining and defending our assumptions. Throughout this process they generally have things they want to change so we have to go back and revise our assumptions. Even if they're interested they'll often ask for more data so we then do a deeper dive in the market and tweak the model to reflect new data.
2) You deal with a lot of rejection. Once we he our heads around the deal we take it to capital providers. We try to take each deal to partners whose risk profiles and areas of expertise match the deal. For example if there’s space for multifamily units we might start by taking the deal to firms that can do some vertical construction. However it’s very difficult to get a partner for the deal, especially if the deal is a little hairy. We often hear “it’s interesting but…” or that it doesn’t quite fit the firm’s mandate. If the deal isn't in a prime market and has some issues with it (for example the sale of an entity vs. an asset sale), it can be hard to capitalize. Even for more straightforward deals I’ve found that it takes several no’s to get a yes.
3) Sometimes the operating partner doesn’t get to operate the deal. Once we’ve got the deal capitalized and we've closed on the property, you’d think that the hard work is over and now we get to do what we do best which is develop and sell the land. This is not always the case. Despite having the expertise, the capital provider brings the money and they often have their own ideas about how to execute the deal. They may want to bulk sale land raw while we want to develop it out. The best deals come out of constant communication between the capital provider and the operator so that everyone is on the same page. If you don't have the same vision for the property as your capital provider, that can lead to deals not performing.
4) You don’t get paid until the end, but your return on equity can be huge. Land deals normally work like a J-curve. You have the initial outflow of capital, then in a few years you (hopefully) achieve break even and then it’s all profit after that. As an operator we get paid a promote out of the profits the increases after certain hurdle rates. We may not see significant profits (outside of management fees) for several years. However our profits may be huge multiples of our relatively small co-investment if the deal ends up performing.
Do you earn the development fees/profit as other GC's?
What kind of pref and promote is common for land dev deals?
Do you guys ever go to individual investors to raise the capital? I find you get a better deal that way.. though may be too time intensive if you have to raise alot of cash
Who provides your gp money.. do the principals of your firm have it or do you raise that as well?
It depends. The first hurdle is generally low-mid teens and you get 15-20% after that, then it's maybe an 18% and a 1.7 or 1.75 and you take 20-25% after that, then maybe 30% after a 25 IRR. It's fungible but normally in that area.
We haven't, we focus on private equity firms and hedge funds with real estate arms since that's the industry my bosses used to be in and that's where their rolodex is the best. For smaller deals though often there are HNW individuals bidding against us.
The principals provide the GP money.
That is a more generous promote structure than I have seen from a lot of operators. Are you guys making it up on other fees or are the shops I'm talking with just being greedy?
Thanks for stepping up with the posting. It looks like a good opportunity reading some of the backstory in your earlier posts.
How did you get this position (cold email via board, alumni connections, etc) and what was your experience and background going in?
I coached high school basketball in the off-season during my baseball career and the head varsity coach of the school was an accountant for my boss's old firm and introduced me and I went from there. It was my first real job, I had never had a non-baseball job and hadn't done any internships as I spent every summer playing ball.
Excellent post. Belies the belief that a lot of young people have (I had this, too) that they will just slap their resume on the table and wealthy people (or organizations) will fall over themselves to throw money at deals. I'm sure you face a ton of rejection because the investors feel that the opportunity cost is not there, meaning they can put their money to better use with other investments, possibly with other people.
I definitely thought it'd be way easier to get funding. It's not always about how attractive the opportunity is, there's a lot of CYA. More than once we've had funds say "sorry we can't do it" but then the guy we were dealing with at the fund has offered to buy into the deal personally.
100% this. I read so many comments on this board of people assuming that if the opportunity is right, money will be there, let alone if the resume is right. This is almost never the case; every investor needs to be sold, every time, on every deal, and sometimes better deals get passed on in favor despite them being partners in a previous "worse" deal.
Track record is more important than returns (to a point), resume, network, quality of a pitchbook (lol) or any of that crap. My experience in development has been that equity partners and lenders are far more comfortable investing at an appreciably lower cap rate/IRR/multiple (depending on your metric) with a partner they trust to execute then in a home run deal with an unknown.
What youre trying to raise money for is probably a bit harder than other aspects of real estate
I do this sort of stuff on behalf of clients and some asset classes are def a hell of a lot easier than others
I think in land you're going to see a shift as institutional investors shy away from it. I think that land is going to end up being more of a HNW and family office type deal where they have lower hurdle rates and longer time horizons.
Institutional $ usually only chases urban infill locations but I agree otherwise. All our urban market deals are institutional $ and our secondary/tertiary market deals are principal $. However, it's the latter of the two with better cash flow.
I think you are asolutely right on this one, land being a more family office type of deal. Also, I will take this chance to thank you on your brilliant post!
Wow - that is a fortuitous break - yet, makes a lot of sense considering the nature of the business.
Excellent post! What margin of safety would you recommend for small single family RE portfolio to survive a downturn? For Example: Combined Property Value: 1,000,000.00 Location: Mid-west (Texas, Oklahoma) Property Class: Residential in great school districts LTV: 70% CAP Rate: 8% Assuming 700,000.00 loan @ 5% = $3,757.00 PMI payment.
The bank requires 6months PTI to get a loan and I have heard some recommend 12 months PTI. Either way it does not seem like a lot. Just wondering what the pro’s are doing?
Appreciate your time!
We don't have rental portfolios, we sell our inventory either to builders (either bulked raw or developed) or in some cases to end users. 12 months in your case is about 45,000, that's a lot of cash to just have sitting on the sidelines earning nominal interest. I'd try and stay around the minimum just because you can deploy the cash elsewhere.
Wow what do you mean by tertiary? 8% of replacement cost is on par with Detroit. We typically just expand out from our target cities, ending up in Fort Worth, Belleveue, Anaheim/Irvine etc.
Pinkpolo how come a couple of your threads have gotten wiped out (e.g. Private Money Land Investing)
Like a B- or lower market. I mean it's pretty subjective how you classify them but somewhere that isn't a "sexy" market or a gateway market, something like that.
Yeah it's very cheap but there are some mitigating factors that are priced in. Also the first developer had a very poorly thought out plan so he put a ton of money in the ground and never got anything out of it.
That one is supposed to go up monday and I put it in the hopper today and I think I accidentally posted it.
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