Family office executives often express frustration that they are not treated like institutions. They see institutional money getting preferential deal-flow and rates.
They see established institutional brands respected in the market and fund managers who get paid significantly more than them. There is a competitive element to these observations and sometimes you hear family offices say proudly that they prefer to play in the institutional space. But does it make sense to compete against institutional money in the real estate sector?
The only way to access significant deals early is to have participated in significant deals previously
Privately two family office advisers talked to me anonymously about the benefits and drawbacks of competing against the funds. One expressed doubt that family offices should try and compete: “Family offices have delusions of grandeur when it comes to competing with real estate institutions,” says one. “In reality, very few family offices are able to compete with a private equity fund above a certain level.”
One of the main problems, according to this family office real estate professional, is that offices can’t attract the expertise they need to seriously engage in big real estate transactions because they will not reward staff the same way funds will. “Ask a really smart guy coming out of Goldman Sachs where he wants to go? After looking at a family office, and how they will not pay carry as funds will, he will likely decide to go to a fund or start up his own business”.
Then there is the complicating factor of the principal and the fact that family office funds are limited. “Family offices can be unreliable partners because they are driven at least in part by emotion and often have key-man risk. Their liquid assets are also limited when compared to pension funds who invest year on year,” says a family office executive.
The point seems well made. Reputational problems, such as those currently buffeting Invoke Capital’s principal, Mike Lynch, have a disproportionate impact on private investment offices. And while his war chest of £770 million is not to be sniffed at, typically a family office will only invest a small proportion to real estate, and that will pale against institutions like BlackRock who can invest huge amounts every year.
Family office decision-making is idiosyncratic when compared to institutions who are much more process and compliance driven. Funds are considered predictable.
Conversely family office governance typically rests on the shoulders of just one principal or a small number of individuals. They may make decisions which are not driven by the typical capitalist criteria of maximising reward. They may prefer real estate locations, asset classes or buildings which they are emotionally attached to. Certainly, family office professionals regularly bemoan the fact that they are asked to work to investment criteria which are ultimately discarded by their principals.
One area where families may be thought to have an edge when it comes to investing is so-called patient capital. Institutional time horizons are approximately 5-7 years, but stereotypically family offices are thought to have generational time horizons.
Indeed some have a default approach of never selling real estate. Others take a different approach. They have specialized so much in real estate that they are indistinguishable from developers or commercial real estate businesses. These families are happy to buy and sell as the market cycle allows.
In some respects, patient capital isn’t much of an edge in real estate because usually, the seller doesn’t care what you are going to do with the asset. Family business owners might balk at selling to private equity because they prefer to sell to another family who shares their ethos. In this way, they seek to protect their legacy. As such the ethos of the buyer may have a significant impact on asset-backed transactions like the sale of a prominent department store. But generally speaking, it is less important in pure real estate plays.
What is crucial is getting access to real estate when it becomes available. Deal-flow is a big issue for family offices as against large institutions like ING. “There are no such things as off-market,” says one family office executive: “And the only way to access significant deals early is to have participated in significant deals previously.”
“Who do you think agents are going to call first if sellers have a fantastic opportunity?,” says one family office manager. “They are going to talk one of the big institutions where they have established relationships. By default, most SFOs will not get shown the best deals.”
Because of this many families stick to the sub-$20 million level or join a club deal outfit where the individual assets are priced at that level. “Stick with those who have an investment range where it’s too expensive and not efficient for a fund to look at,” says one family office executive.
According to a number of family office manages I spoke to – that investment “level” is around $20 million. As a rule of thumb, funds don’t play in the sub $20 million space. Between $20-50 million funds will begin to compete and $50 million-plus is almost entirely reserved for institutions.
One way to play is to team up with another family who has market experience.
“There is value to be had from a club or multi-family type format to access the market. Of course, you still need synergy and trust to make it work,” says Rupert Dehaene-Gold of Riverton, a family office vehicle offering co-investment opportunities.
Ultimately, it seems only a small percentage of families can compete with institutions: “This is a fallacy in the family office world. With some exceptions, they think they can play with big boys and they cant.”
But family offices do have at least one distinct and important competitive edge: Timing. Unlike institutional funds, family offices don’t have to deploy money. This can be particularly helpful if, as at present, there is a growing belief that assets are overvalued and a big correction is coming. Being a patient bargain hunter might then be the best game in town.