Finding Your Growth Guru

By Michael Episcope

In the public equity markets, the difference in performance between top- and bottom-quartile real estate investment managers may be only a few percentage points. Yet the choice of a private manager can mean the difference between doubling your capital and a total loss.

This harsh reality explains why I would argue that the most important decision in real estate investment is the selection of the investment manager. When it comes to real estate, it’s less about what you invest in than whom you invest with.

The Partners Group Thomson Reuters Real Estate Index, which reports a range of private real estate results, shows that the best investment managers kept their funds profitable in the real estate downturn, while others suffered massive losses.

What separates good managers from bad? In order to find out, I recommend asking the following questions:

1. What is the manager’s financial stake?

The manager should have real skin in the game, not merely enough to check the box. Managers who invest significant capital in a project will have goals that align with yours.

That can include entrepreneurs who invest their own capital, have raised money from friends and family, or have substantial funding from the firm’s employees. For example, one third of the funding for investments at Origin Investments is provided by me and my partner, David Scherer.

2. Does the manager have a team?

Acquisitions, asset management, accounting and investor relations should all be handled by separate departments. Bigger isn’t always better, but there is a happy medium between a large bureaucratic institution and a two-guys-and-a-truck operation posing as a manager.

A 2015 report from PricewaterhouseCoopers makes the case that alternative investments, such as real estate, make special demands on sales and administrative staff: “Investors in alternatives require higher touch, with more interaction and education, than mutual fund investors due to the complexity.”

3. Are there potential conflicts of interest?

Vertical integration can work for companies that invest their own capital, but those with in-house construction, property management and asset management divisions might be susceptible to conflicts through self-dealing. In those situations, I worry that the decision to sell becomes an internal conversation about protecting a property management revenue stream, rather than a discussion about what’s best for the client.

4. How are fees charged?
Real estate requires active management and a great team to be successful, and transaction fees help pay for that team. However, fees should keep the lights on and not be a profit center. Look for a fee structure that is largely performance-based, so the manager wins when the investor wins.

Furthermore, beware of the joint venture. This may sound great in theory, but in practice, two managers instead of one can mean double the fees.

In general, run from investments that advertise little or no fees or, at the other end of the spectrum, charge exorbitant fees upfront. A good standard: The best managers invest more than 95 percent of every dollar that comes through the door.

5. How strong is the balance sheet?

The balance sheet tells you if the manager has the capital to fulfill its obligations over the long run, such as meeting payroll, funding deals and solving problems when things go wrong. A large cash position and limited leverage indicate that the manager who oversees the fund will weather short-term setbacks and work toward long-range goals.

Investors also should look for transparency in financial reports on the manager’s past deals, both in audited annual reports and in quarterly updates. Whatever accounting methods are used, investors should clearly understand the project’s capital commitments and income tax implications.

6. What’s the track record?

Managers should have at least 10 years of experience in the industry. News coverage can suggest the company’s scale and expertise. Also, look closely at how the manager’s last five sales have panned out in realized returns.

Finally, multibillion-dollar institutional investors often ask us to tell them a tale of an investment that went poorly and how we handled it. Be sure to ask that question, because that’s where the manager’s honesty and integrity truly shine through.

A 15-year veteran of real estate investment, Michael Episcope is co-founder & principal of Origin Investments, an institutional investment platform that acquires and develops office and multifamily assets. Based in Chicago, Origin has additional offices in Atlanta, Charlotte and Dallas.