From Country Clubs to Sovereign Wealth Funds

The country club model—where real estate sponsors raise money from rich friends via a syndicate—has been a tried-and-true way to fund projects for generations. But for sponsors of traditional real estate projects and OpCo-PropCo platforms looking to scale larger portfolios, access to larger pools of capital are needed beyond country club checkbooks.

As a sponsor grows and reaches larger–and more sophisticated–investors, different investing structures become necessary. This letter will dive into the most popular of those structures:

• Services agreements, a step toward—or alternative to—joint ventures;

• Joint ventures, scaling quickly with a single partner;

• Syndication, a deal by deal approach;

• Institutional funds, maximum scale and control;

• Separately managed account, a hybrid between a fund and a joint venture;

• Venture capital, a funding alternative for scalable OpCos;

By comparing and contrasting these models, this letter aims to equip sponsors and real estate entrepreneurs with the knowledge to select the most suitable path for growth and success.

Service Agreements

A step toward—or alternative to—joint ventures

Services agreements are ideal for emerging OpCo-PropCo platforms that may have an opportunity to scale quickly but lack the capital to co-invest in a joint venture equity today.

Service agreements are commercial arrangements where the investor engages a sponsor for specific services, usually to acquire and manage assets within a specific buy box on their behalf.

For example, a single-family rental (SFR) investment platform would enter into a service agreement with a large private equity fund to acquire and manage a portfolio of single family rental assets on their behalf, leveraging the platform’s acquisition and management expertise while adhering to the fund's strategic directives and buy-box requirements.

The SFR platform is paid acquisition and management fees on every home and may be paid a carried interest in the investment but does not participate with its own capital. In these agreements, the sponsor is not the general partner (GP) and only acts as a service provider to the investor.

The investor provides the sponsor or OpCo-PropCo with little-to-no decision-making control. But the structure gives the investors more comfort to invest more money–more quickly–with earlier stage groups. This helps those early-stage companies develop their track records to raise capital in the future.

• Structure: Commercial agreement between one Capital Provider and one Sponsor whereby Sponsor is paid for specific services.

• Control: In this option, Capital Provider has maximum control and Sponsor executes at the direction of Capital Provider.

• Capital contributions: Typically there are no Sponsor´s capital contribution requirements or are less than required for other options.

• Exclusivity: Both Capital Provider and Sponsor typically require exclusivity for specific strategy or geography.

• Investors: Mostly private equity real estate funds, private REITs,and large real estate operators.

• Compensation: Wide range of compensation alternatives. Typically less than JV if Sponsor is not contributing capital but in certain cases can be structured to be similar to JV with acquisition fees, asset management fees, property management fees, development fees, disposition fees and promote.

• Track record requirements: Sponsor or its leadership must have successful prior execution of the specific strategy but can accommodate teams that have recently left a prior employer and does not require having raised capital before.

• Compliance requirements: Specific to the Capital Provider´s requirements.

• Outs: Capital Provider will have multiple outs including performance below minimum requirements. Sponsor may have outs if the Capital Provider does not approve several investments.

• Size: All sizes but most require more than $10-20mm of investment from the Capital Provider.

• Time required to close: Similar to JV (3-6 months), can be shorter than syndications and much shorter than funds

Joint Ventures

Scaling quickly with a single partner

Joint ventures are collaborative partnerships between sponsors and investors around a specific investment strategy in which the sponsor participates as an investor in the GP.

Typically, these arrangements require that the sponsor has a meaningful track record related to the strategy as well as a live deal pipeline requiring significant capital.

Joint ventures are an alternative to raising a discretionary fund. They are much faster to raise, as the sponsor only needs to find a single LP investor, but fees and controls are typically much lower and more limited for the sponsor.

• Structure: Agreement between one Capital Provider and one Sponsor. Sponsor contributes part of the capital, typically a small percentage.

• Control: Typically Sponsor controls all major decisions and Sponsor has minority protection rights. Sponsor executes strategy.

• Capital contributions: Capital Provider contributes majority of capital and Sponsor the rest (GP capital). Capital from each has the same economic rights, proportional to each contribution.

• Exclusivity: Both Capital Provider and Sponsor typically require exclusivity for specific strategy or geography.

• Investors: Mostly private equity real estate funds, private REITs, large real estate operators, some large pension funds, endowments, insurance companies, and sovereign wealth funds.

• Compensation: Typically more than services agreements and less than syndications or funds. Can include acquisition fees, asset management fees, property management fees, development fees, disposition fees and one or more levels of promote over minimum hurdles.

• Track record requirements: Sponsor or its leadership must have successful prior execution of the specific strategy but can accommodate teams that have recently left a prior employer. Does not require having raised capital before but Capital Provider generally requires Sponsor to have had experience with institutional capital.

• Compliance requirements: Specific to the Capital Provider´s requirements

• Outs: Capital Provider will have multiple outs including performance below minimum requirements. Sponsor may have outs if Capital Provider does not approve several investments.

• Size: All sizes but most require more than $10-20mm of investment from the Capital Provider. Some can grow to nine figures.

• Time required to close: Similar to services agreement (3-6 months), can be shorter than syndications and much shorter than funds.

Example Transaction

A real estate development firm partners with a private equity real estate fund for a large-scale residential project, contributing a 10% of the total equity capital required and taking the lead on all development, leasing and asset management decisions.

The development firm is paid acquisition fees, development fees, asset management fees and a promote that is equal to 15% over an 11% preferred return hurdle to the private equity real estate fund.

Syndication

A deal-by-deal approach

Syndication allows sponsors to raise capital from various investors for specific projects. The country club model is an example of a syndication.

The sponsor typically controls the investment post-funding, with capital contributions and economic rights being proportional. This option is ideal for sponsors with a strong individual investor network and typically offers higher compensation compared to joint ventures and service agreements.

• Structure: Sponsor raises capital from multiple capital providers, typically high net worth individuals and family offices on a deal-by-deal basis. Depending on the number of investors and controls, the syndicate may need to comply with minimum SEC rules.

• Control: Each investor decides to participate in an investment opportunity but Sponsor typically controls all decisions after investments are made subject to previously agreed upon parameters

• Capital contributions: Capital Providers contribute the majority of capital and Sponsor the rest (GP capital). Capital from each has the same economic rights, proportional to each contribution.

• Exclusivity: Agreement is typically limited to one project or a predefined list of projects.

• Investors: Primarily high net worth individuals and family offices.

• Compensation: Fee percentages are typically higher than services agreements and joint ventures, and can be similar or higher than discretionary funds.

• Track record requirements: Sponsor typically has had experience managing third party capital–but not necessarily institutional capital.

• Compliance requirements: Depending on the number of investors and controls, may need to comply with SEC disclosure and reporting requirements.

• Outs: Minimum outs for all parties as investment is typically limited to one project

• Size: All sizes. Can be less than $1mm but few larger than $100mm.

• Time required to close: Depending on Sponsors relationships and capital raising capabilities. Separate capital raising for each deal.

Example Transaction

A local real estate development firm specializing in retail projects organizes a syndicate to fund the redevelopment of a strip retail center. The syndicate raises $20 million specifically for this project through a combination of high-net-worth individuals.

The sponsor, who is responsible for managing the project, is compensated based on a "2 and 20" model similar to that of the fund example. They receive a 2% management fee on the total capital raised (2% of $100 million) for operational expenses and management of the project. Additionally, they earn a 20% share of any profits generated by the project, but only after the investors receive a predetermined preferred return, say 8%.

Institutional Fund

Maximum Scale and Control

Funds involve raising capital in a pooled format, offering the sponsor significant control over investments.

In a fund structure, sponsors raise discretionary capital from a wide range of investors in a blind pool. The sponsor maintains most control.

Funds have the strictest compliance requirements and offer the higher compensation, with common structures including asset management fees and significant promotes. However, they require a considerable track record, more elaborate compliance and a longer time for capital raising.

• Structure: Sponsor raises discretionary capital in a blind pool from multiple investors. Investors can be of all sizes but typically accredited or larger.

• Control: Once investors decide to invest, Sponsor retains most of the controls.

• Capital contributions: Capital Providers contribute the majority of capital and Sponsor the rest (GP capital). Capital from each has the same economic rights, proportional to each contribution.

• Exclusivity: Sponsor is generally exclusive to the fund but investors are not.

• Investors: All sizes and categories. From high net worth individuals to sovereign wealth funds.

• Compensation: For funds, 1.5% asset management fee and a promote of 20% over a hurdle of 7-8% is common. Fees are higher than those for JVs or service agreements.

• Track record requirements: Most rigorous in terms of investment and capital raising track record. Sponsor is typically required to have managed third party capital. Most institutions don’t invest in first time funds.

• Compliance requirements: Strictest compliance requirements per SEC rules

• Outs: Very few outs. Fund typically have a predefined life (closed end funds) or have liquidity provisions and no predefined term (open ended funds)

• Size: Due to legal and compliance costs, funds tend to be larger, typically not smaller than $100mm and up to several $billions.

• Time required to close: This option takes much longer to raise than the others. In the current market environment, first time funds are taking more than 18 months to raise, and follow on funds are taking over 12 months.

Example Transaction

A prominent office real estate firm who previously syndicated investments on a deal by deal basis establishes a $500mm fund focusing on urban redevelopment projects, attracting a mix of family office, sovereign wealth fund and insurance companies, exercising comprehensive control over investment decisions.

The sponsor is paid on a "2 and 20" model, meaning they are paid a 2% annual management fee on the assets under management (2% of $500mm) and 20% of the fund’s investment returns over an 8% preferred return to investors.

Separate Managed Account (SMA)

A hybrid between a fund and a joint venture

A SMA is a joint venture between a Sponsor and a single Capital Provider–typically very large family offices, pension funds, endowments and sovereign wealth funds.

SMAs typically have characteristics that are a hybrid between a Fund and a Joint Venture:

• Structure: Structured like a Joint Venture

• Control: Capital provider has more control than in a Fund and equal to or less control than in a Joint Venture

• Capital contributions: Capital providers contribute the majority of capital and Sponsor the rest (GP capital). Capital from each has the same economic rights, proportional to each contribution.

• Exclusivity: Sponsor is generally exclusive to the fund but investors are not.

• Investors: Suitable for larger investors.

• Compensation: Typically a similar but reduced fee structure compared to a fund

• Track record requirements: Similar to a joint venture

• Compliance requirements: Dependent on capital provider

• Outs: Similar to a joint venture

• Size: Tend to be larger $50mm+

• Time required to close: Generally a bit longer than a joint venture as the larger investors tend to have a longer decision-making process

Example Transaction

A prominent office real estate firm who previously syndicated investments on a deal by deal basis establishes a $300mm SMA with a sovereign wealth fund for an industrial strategy in Texas. The investment "box" is clearly defined. The Sovereign Wealth Fund retains deal-by-deal approval but Sponsor is given operational flexibility within a previously-approved business plan.

The sponsor is paid 50% of the traditional "2 and 20" model: an annual management fee on the assets under management (1% of $300mm) and 10% of the fund’s investment returns over an 8% preferred return to investors.

Venture Capital

A funding alternative for scalable OpCos

Venture capital funds may provide a source of capital to OpCos that have the potential to scale significantly. Other sources of capital are generally not suitable for this purpose. High net worth individuals ("angel investors" in venture terminology) can usually not invest at the size required, and private equity real estate funds are generally not allowed by mandate to invest in OpCos. Venture funding can be provided by dedicated venture funds or by family offices who often participate in venture deals.

Note: venture capital is generally not an appropriate source of funding for PropCos, as venture firms have very high return requirements and typically do not write the check sizes that are required by PropCos. That said, some venture firms have affiliate vehicles that invest directly into real estate –for example, see the recent Thesis Driven article on Alpaca, a firm with both venture and PropCo funds.

Summarizing decision-making

As reviewed, Sponsors have a wide variety of choices of investors and structures to fund their growth. The right choice will depend on the Sponsor’s track record, balance sheet, and project characteristics.

• Sponsors and OpCo-PropCos with no capital or track record should consider services agreements to build that track record.

• Sponsors and OpCo-PropCos with a solid track record but no background in investment management and/or with a need to raise money quickly should consider joint ventures or SMAs.

• Sponsors and OpCo-PropCos with a strong network of individual investors should consider syndications, especially if only looking to fund individual deals.

• A fund offers the best scale and control for the sponsor but requires the longest track record and timeframe for capital raising.

As sponsors navigate the funding landscape, it’s critical to align their funding choice with the organization's track record, financial capabilities, and specific project requirements–and ensure it fits into a larger strategy for future capital raises.

—Paul Stanton and Sandor Valner