A real estate syndication and a real estate business are two very different things.
Real businesses produce repeatable, monthly cash flow to support overhead and staffing. A real estate syndicator creates and manages deals. Both paths are fine, but it’s important not to confuse the two.
Real Estate Platform Flywheel:
Recurring revenue is the lifeblood of every rental property, yet most small investment firms are oddly allergic to this concept for their own business. General partners (GPs) and their investors (LPs) are far more comfortable with fee-light structures that forgo cash flow in exchange for back-end profits tied to performance.
This isn’t necessarily a problem. A heavily weighted promote structure is best for one-off deals. It’s effective for a sharpshooting, syndication strategy. Higher reward potential, but higher risk if that one deal doesn’t perform. This structure is ideal for LPs that have the time and expertise to consistently evaluate deals and diversify with multiple operators.
However, this structure is challenging for small operators with large ambitions. They can often take on too much, too fast. Brute force can get them through, but not forever and not at scale.
If a real estate syndicator wants to build a real business, they need to hire. Unfortunately, great people are not cheap and one can’t hire 1/4th of an analyst or asset manager while they ramp up. Small firms are forced to hire too early, or more likely, too late.
This is the messy middle.
The faster an operator can afford elite people to take the reins on asset management, finance, and investor relations, the better. If a real estate team has a clear and long runaway (perhaps a niche strategy), they might want to consider taking growth capital. This type of funding is rarely utilized in real estate, but it’s the fastest path to sustainable operations. It’s also how some of the largest REITs were formed.
To be clear, there is nothing wrong with staying small. You can be big or boutique, but you can’t be medium. The firms that make it to the next level the fastest understand this. They structure their deals, strategy, and capital to align with a long-term view of their business. That might mean sacrificing back-end profits for higher management fees, forming joint ventures with local partners, or accepting lower returns to pay for quality property management.
These firms may not deliver world record IRRs on every deal, but they can deploy capital and deliver returns (with lower risk) consistently, which is far more valuable than a one-time, high IRR outcome. The goal – especially for limited partners – is to find people or investments you can count on for SOLID (not miraculous) returns for 20+ years. The holy grail for investors is to make one decision on a company, person, or team and reinvest with them for a lifetime.
REITs Are Repeatable To help achieve the above, we believe all real estate investors should own private real estate AND public real estate (REITs). This is for several reasons, one of which is that most REITs mastered the above flywheel a long time ago. They’re past those awkward teen years. The average REIT owns a multibillion-dollar portfolio and is staffed by seasoned operators. These people are well compensated with liquid stock and have ample growth opportunities within the firm.
By design, REITs cannot be ‘closely held’. No one person can own more than ~50% of the shares. Therefore, REIT employees often own large percentages of stock and are incentivized to drive shareholder value over the long term. Stock awards are a powerful employee retention tool that aligns well with investors. More often than not, this leads to stable operations, repeatable systems, and growing profits.
REIT Capital Flywheel Additionally, REITs have a 2nd flywheel unavailable to private firms. Top-tier REITs use their stock price as a weapon to boost returns.
This is a powerful compounding tool that we’ll cover in more detail in another memo. However, at a high level, the REIT capital flywheel looks like the following:
….which boosts the acquisition pipeline, restarts the cycle, and round and round we go.
We believe the market under appreciates this reflexive benefit of REITs. This is partly why REITs have historically delivered higher market returns than the overall market - despite the lower absolute risk (not to be confused with volatility “risk”) - while distributing more cash flow to investors.
Growing dividends and well-compensated employees are clear signs of thriving real estate business. To learn more about Private REITs by emailing [email protected]
