LP Equity Partners - dying breed? Why not go direct?
I work on the GP side in mixed-use and residential acquisitions. We just closed our first deal with a very large institutional asset management group. This group also happens to invest in the funds of one of our large LP partners.
They essentially cut out the "middle man" and partnered directly with us. Do you think this could be the future, I am not sure what value large LP fund managers bring to the table these days. The alternative would be for large LP fund managers to stop partnering with GPs and just buy direct, but I think the former is more likely.
This basically comes down to the difference between why you would invest in funds vs a direct deal. A fund offers an investor a portion of a large pool of capital spread across multiple deals as opposed to putting all your chips in one basket. If an institutional asset manager builds a relationship with a GP and strongly believes in a deal that a GP is offering, then you could see some of that one-off direct investment that you're referring to. But an institutional asset manager doesn't have the time or care enough to underwrite one-off deals, which is why the LP/GP fund relationship is where I bet most of the institutional capital will continue to stay.
They bring diversification (you own a pool of assets rather than just one) and most importantly - the ability to put millions of dollars to work without taking much “manpower” from the Pension fund.
The man hours required to underwrite and fund a $50mm deal (putting 15mm of equity to work) is probably similar to the man hours required to commit $250mm of equity to a particular fund’s strategy.
Pension funds have billions of dollars to put to work. It would be a massive under-taking to deploy all of that into individual deals. Instead, they can do $50m of equity to one fund, $100m to another, etc in a much quicker timespan. Obviously they have to pay fees, but that’s a trade off pension funds are willing to take to reduce risk, save time / get money out the door quickly
But couldnt a Pension Fund just save on the promotes, carried interest, and AM fees and just hire the LP groups directly? That way there is not two "layers" of promote.
Then you lose the diversification aspect. If you want Kayne Anderson to focus their time and efforts on a separate account with you (they’re not currently in this business) then you’d have to give them probably a $bn+ or some other significant amount of money. This means the pension fund would be over-allocating into Student / seniors housing in the southeast which Kayne Anderson focuses on. Also the “man hours” come into play again. Structuring an individual agreement with Kayne Anderson takes time - more time than just signing on the dotted line to terms that have already been set by “Kayne Anderson RE Partners Fund IV”.
You should look into Michael Dell’s family office MSD Capital. Basically MSD Capital is the GP in the MSD Partners fund. They pool the MSD Capital funds alongside outside LP investors and then partner with Operators on RE deals. This way, Michael Dell isn’t getting a Fee’d to death (he actually takes some himself) and then he also has the benefit of putting a smaller % of his net worth into each deal they buy. Maybe more LPs will use this method going forward.
When LPs see the fees they pay to GPs, they always say to themselves, "Hey lets do this ourselves". Almost the majority of scenarios I have seen this happen, the LP has gotten screwed.
There will always be LPs and GPs. GPs are experts in their specific field. I know one such LP group that got into hotels. They bought a portfolio themselves and hired a premier management company to run it. In the end, they got screwed. Management company did fine, but theyre job was to simply manage not just focus on the bottom line. Expenses skyrocketed and they ended up selling the hotels for a 20%+ loss. Most GPs earn their fees. We work our asses off and add value to the deal. LPs just want to invest.
As for LP fund managers, I cant speak to the future of them. I feel like they do add value for vetting deals and have relationship connections. Maybe someone else can give insight into this.
I understand the sentiment, but this is essentially the same reason that you'd pay any service provider for their services: you value their expertise and are willing to compensate them for it.
Your logic does not stop at a fund managers. Why not cut out the GP, Prop Mgmt, Leasing, etc and do all of that in house too? This isn't a crazy example, several Canadian Pension funds actually operate this way.
The reason my logic stops at fund managers is because of the amount of capital out there compressing yields. JV structures these days have gone from an 11-12 pref hurdle to a 9-10 pref hurdle. These LP fund managers promise their pension funds/other LPs an 8% return. LP fund management is simply getting less profitable unless their pension funds/other LPs stomach lower returns. At this point, it seems to make sense for those pension funds/other LPs to stop paying an AM fee, stop promoting the LP fund managers, and just hire acquisitions people to vet deal level opportunities themselves.
I agree with most of what the other posters have said about diversification, expertise, etc. but they're all missing a big point. THESE ARE FREAKING PENSION FUNDS, have you ever worked with one? They are just as CYA as any other government organization and maybe only slightly more efficient, do you really think they're equipped to go do the investments themselves?
Yeah you have some savvy ones, and they may do direct investment, but most LPs use a GP as a way to point the finger at someone else if things go poorly.
Yes.
a lot of pension funds are hiring acquisitions people and going direct for this very reasons.
This is already happening. This is why OpCo level investments in outperforming operators is prevalent in today's market.
Instead of Institutional Investor --> LP --> Multiple GPs som are Institutional Investor --> Single investment at opco level in high performing GP.
This allows the II to participate in some of the fees, save on fees paid through working with an LP, and put their money in what they perceive to be a longer term stable investment.
With respect to diversification: the pensions/foreign accounts are still diversifying.. just in a different manner. They'll pick 2-3 Gps to get under the tent with in each sector they're interested in.
Some pension funds (CDPQ is one, so is CPPIB) also own operating subsidiaries that manage all of their portfolio.
Lot's of these traditional "LPs" are hiring real estate teams. Some are buying direct, or just using the RE shop to act as a "front man" (for just small asset mngt fee, maybe some acq fee if they manage that part). Many big money pools (pensions, SWFs, endowments) rather not have their name associated with ownership or management, thus like the insulation an investment mngt shop can provide (plus the access to depth of people can't hurt in a pinch).
Others are just negotiating down fees they pay in funds or switching to Separately Managed Accounts (SMAs) with much lower fee structures. This trend will continue and overall fees (AM and Acq) will decline/compress as will the big promotes. Just natural evolution (even associations of LPs trying to accomplish a form of collective bargaining).
Can the BX/SW/KKR types keep the magic going? Maybe, if they can justify the fees via returns and assert that no fair way to segregate services so either invest in the fund or get bent (not sure if that is their pitch, but I'm guessing it has to be). They seem to recognize the profitability of PE investment mngt will compress, hence why they are getting big, diversified, and going public (like with BREIT, etc.).
I work on the development side, so can’t speak to acquisitions, but I’d certainly say we bring to the table expertise that cannot be replaced across risk management, financial structuring, investment analysis, et cetera. So it would be more of a choice for the LPs of bearing that payroll cost or outsourcing it. Certainly the job is not going away.
Furthermore, there are a different set of incentives that LPs should find more attractive by using investment managers vs going direct. Operators would do every deal if they could to earn their fee and live and die by those fees, not their promote. I can attest to this by the layoffs I witnessed at developer shops due to COVID solely due to us hitting pause and the fee going away. Development shops run particularly lean, so again, can’t speak for the acquisition guys. This compares to Investment manager incentives which are more performance based.
Overall, I think it would require an insurmountable infrastructure investment by the LPs for us to go away totally
In addition to the salient points made above, this question also boils down to what is essentially a bet. While there will always be LPs (typically generalists) and GPs (typically specialists), the lines are getting blurred as they are vertically integrating and encroaching on each others territory.
Hence the bet, is it more likely that LPs will get smart about new property types (underwriting & managing) enough to effectively compete with GPs in their chosen specialty? They can already raise huge funds and know the finance/fund structuring side cold. Or will it be more likely that GPs will get smart about fundraising and finding capital sources, as they know their sector well enough to put the money to work? My initial thought is the latter is a stronger bet due to expertise taking longer to attain and thus more valuable, but I can see the merits of both sides.
I don't think so, personally. GPs know how to get actual property-level transactions done, they know how to operate the real estate, they are the ones that are experts in their markets and getting invites to brokers' family BBQ parties. Access to macro-information and institutional capital is getting easier for GPs. LPs are essentially "middlemen" that will get squeezed out before GPs do.
I have worked on both the GP and LP side, and LPs just spend most of their time making up bullshit busy work to appear valuable to their investors; running countless sensitivities, analyses, trying to stay informed on macro trends. On the GP side, I am actually building local relationships, vetting out property level contracts, walking roofs with our engineers, meeting with municipal officials, exchanging memes with brokers, and not wasting time on trying to quantify the unquantifiable.
Although I recognize the efficiency from a GP POV of raising a fund and not having to raise capital for individual transactions, I will never understand why a sponsor group would want to give up their best asset - which is individual deal performance/promote. GP funds (as in funds for the GP co-investment) make a ton of sense because you can then charge AM/performance fees off that bucket of capital and enhance your ability to do more deals, but if I'm a sponsor I will always want to have the ability to drive promote off individual deal performance and not have the crossed economics of a fund. Unless, of course, you've realized that you are in the fee game and not the promote game, which some larger groups have realized.
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