How Smaller Real Estate Investors Can Attract Private Equity to Their Projects

Working with and learning from experienced real estate professionals can give budding investors the boost of confidence they need to take on new initiatives, such as branching out into new asset classes or purchasing and operating larger properties. By bringing on a private equity investor experienced in real estate, those with small holdings or new to the industry can gain contacts and learn best practices that may help them move to the next level.

To learn what private equity investors look for when placing capital in projects with smaller real estate investors, LoopNet spoke with Lynn Jerath, founder and president of Citrine Investment Group, a private equity and advisory firm actively investing in real estate, including adaptive reuse, value-add, land entitlement and opportunistic transactions.

“Private equity sounds like a big, big term, but at the end of the day, private equity just means dollars coming in that aren't from the public markets,” Jerath said. “So, it could be a huge multi-billion-dollar institution investing, or it could be an individual saying, ‘I believe in you, and I'll put money in.’ So don't get deterred by that term,” Jerath added.

There are a variety of roles that a private equity provider can play in a real estate project. In some instances, they serve as passive investors simply allocating capital. According to Jerath, with this arrangement, the split is usually 90-10 or 80-20, with the development or operating entity contributing most of the time and talent to the project, while the private equity investor provides the majority of the funding.

In other cases, there might be what Jerath calls a “partnership of equals.” She said these arrangements typically occur when private equity firms form partnerships to leverage expertise they may lack in-house. In this case, “you're getting the best of each party’s operating platforms, and both are bringing capital to the table,” Jerath said.

For example, a mixed-use developer that has little or no experience with residential projects may partner with a strong multifamily developer, not so much because they need additional capital but to attain particular expertise. In such a scenario, the expertise in question is so critical to the success of the project that the investor initiating the project is willing to take on the complexities of a partnership as well as give up some percentage of ownership.

Assuming she were a passive investor in a small project, Jerath said there are several characteristics she looks for in the people and projects she assesses for potential co-investment.

Building on a hypothetical example that LoopNet posed about an office owner seeking a capital infusion in St. Louis, Jerath said, “if I was the allocator of capital [and not] … the active operator or developer on the asset, and I had investors who were looking specifically for office exposure in St. Louis, I would look for an owner well-known for their operating prowess and a longstanding history of positive performance in St. Louis,” with opportunities in the right submarkets.

Jerath said that the best operators have history and longevity in their markets that give them unique insights into the local market dynamics and competition. “It gives them a leg up, enabling them to understand pricing and how other owners and operators in their market think,” Jerath added.

An outsider might wonder about the peculiarities of a tenant base such as why lease terms seem to be for five years or less. “If you're coming in from out of town, you may not know why. But a longtime owner and operator in that market will understand [those nuances],” Jerath said.

She gave an example from Columbus, Ohio, a market she’s just begun to explore. “There's so much under construction and it’s a booming real estate market, yet rents are just not that high,” Jerath said. “So, if you're coming in from the outside, that seems kind of strange; you don't have rent pressure, yet you have construction.” How can you make a pro-forma work, she posited?

People who know that market intimately understand the dynamics of why that's happening and how to navigate those conditions, Jerath said.

Another attribute Jerath looks for is access to propriety deal flow. If it's a competitive asset type or geography where it's very difficult to find investment opportunities in general or high-quality investment transactions in particular, teaming with a local operator is attractive. “If you've got a “recap[italization] or partnership opportunity with someone who's got either access to proprietary deal flow or an existing portfolio, that's really interesting,” Jerath said.

Jerath offered several pieces of advice to budding investors who want to enhance their project’s appeal to private equity allocators.

Know Your Passion. Jerath emphasized that the first step is to know your passion. Typically, she said “there's some asset class, some market or neighborhood, or something that's really attracting you.” So, instead of thinking about investing in terms of an asset class like suburban apartments or limited-service hotels that you’ve heard are preforming well, focus on something you are drawn to.

“Some [asset classes] are just not going to be interesting to you, so let your emotions be your guide,” she added. “When you do start talking to investors, they [will] sense the passion. They can feel that you really love this sector or love this market and [investors] want to have a piece of something that you're excited about.”

Start Small. “The second thing is to start small. If you have some capital and you have a deal type that you're really excited about, just start small.”

Jerath clarified that she does not want to dissuade entrepreneurial investors from large projects, encouraging them to take on “whatever you can afford, whatever risk you can tolerate or whatever makes sense to you.” She gave the example of people entering real estate by buying two flats. “They live on one floor and rent out the other and [this arrangement] helps to build equity. Also, from a financing perspective, because it's owner occupied, you get better rates,” and potentially enjoy other benefits such as decreased tax and insurance expenses.

By starting small, “you can cut your teeth by doing something smaller and making mistakes that are smaller,” if you make mistakes at all. This way “you're not betting the whole farm,” Jerath said.

Find Your Niche. Jerath advised concentrating on just one or even a few asset classes in order to develop expertise and build a reputation as a go-to entity for a particular real estate niche.

Jerath said that may seem hard to do because real estate markets are robust and there can be intense competition for assets, but “real estate is still quite a fragmented industry.” She added that “not a huge percentage of the industry is publicly traded. Not a huge percentage of the industry is institutionally owned. There's still so much property that's owned by owner occupants or individuals.” This paradigm creates opportunities for entrepreneurs.

Jerath believes that “finding a niche, getting going in that niche and really establishing yourself,” is a solid path to take for small or novice real estate owners looking to attract capital from external sources over time. She said this approach enables investors to eventually establish themselves as experts, while still starting small.

Network. When establishing a real estate footprint in an area, networking with neighborhood groups, schools, charities, clubs and business groups is an excellent way to get to know a community and begin to establish relationships.

A new immigrant, for example, might reach out to other immigrants already established in the area. “Typically, immigrant communities are very supportive of each other, so find somebody in your community that might have been around a bit longer and has more access to either capital or connections,” Jerath said. By volunteering, getting involved in community groups or in chambers of commerce, new investors can get to know the players in their market.

“In terms of actually attracting capital, what I say is people invest with people they trust. So how do you build that trust? It’s built through relationships,” Jerath said.

And whatever you do, “don’t make the first conversation a transaction,” Jerath cautioned. You should already have “established a relationship around other things before you get to that money conversation.”

Jerath advised that some people may feel put on the spot if this conversation feels abrupt, but if trust is established well in advance, there is a better chance of getting a positive response. She noted that a person you’ve been talking with for two years about ideas and projects you are passionate about is more likely to say, “I'm so excited to see it's coming to fruition. I'd love to be a part of it.”