June 1, 2015

Pulling Together: The Right Local Partner is Crucial for Both Foreign and Domestic Investors.

Source: IREI.com
By Shiela Hopkins

The World Is Flat is no longer simply a best-selling book by Thomas Friedman — it is now a universally understood business-speak phrase that connotes the globalization and interconnectivity of trade and economies. And real estate is a big part of that interconnectivity. Capital flows in and out of regions; countries and continents are growing at an ever-increasing pace. According to JLL, cross-border investment jumped to its highest level on record in the final quarter of 2014, with half of all deals done involving nondomestic parties.

While some foreign investors prefer to acquire assets outright and avoid the potentially complex process of acquiring a property in parallel with structuring a joint-venture agreement, most seem to prefer the security of working with someone who knows the local market. Foreign investors use domestic joint-venture partners as a way to bridge the cultural gap between them and a domestic seller, and as a strategic means of creating a global relationship with a local partner.

“We saw an example of this when we advised Deka Immobilien on their recent acquisition — and first joint venture in the U.S. — of a prime retail condo at 522 Fifth Avenue in New York,” says Robert Stamm, executive managing director of Savills Studley. “Deka, a German open-end fund, partnered with well-established local market expert Ashkenazy to form a strategic partnership, which sets the foundation for the two firms to replicate this success on future opportunities going forward.”

Stamm adds, “It’s a trend which we will see with more offshore investors.”

You do not have to be an international investor, however, to feel the need for a partner with local knowledge. Sometimes “local” can mean domestic, if you are an international investor, and sometimes “local” can be as precise as postal codes in a major city. In any case, local means specific knowledge and relationships that an outsider does not have, but needs.

“We’ve chosen to work with partners in all parts of the world,” says Russell Platt, CEO of Forum Partners. “Even in markets that we know quite well, there’s always someone who has better local access and better-targeted expertise that can deliver added value for us as investors.”

As the world becomes flatter, and real estate becomes more global, the knowledge of local partners becomes more vital. Investors and managers simply do not have the in-house capabilities to know every nook and cranny of every market in which they invest.

“I had a mentor who said you should invest where you live, not where you visit,” says Robert Bellinger, CEO, and president of ASB Real Estate Investments. “The truth behind that lies at the heart of our philosophy of investing with partners. Our partners are our boots on the ground. They live in the markets where we operate, and they provide vital knowledge, skill, and expertise.”

The advantages of using local partners are many — better access to off-market transactions, better access to local vendors, better knowledge of local values and the ability for capital providers to be in more markets than would be feasible if they had to do everything in-house. These advantages come into play for properties all along the risk spectrum, but the more complex the transaction, the more a local partner can add.

Successful investment performance is becoming increasingly dependent on execution because opportunities to make money on the “buy” are diminishing as markets become fully valued. Opportunistic investments, for example, require a significant amount of hands-on attention through lease-up, repositioning, redevelopment and ground-up development.

“Local operators are best equipped to source and execute these complicated business plans,” says David Butler, managing partner at Argosy Real Estate. “We strongly believe that two key components of successful real estate investing are local market knowledge and execution capability, both of which can be enhanced by partnering with local operators.”

“Partnering with experienced local operating partners provides access to specialized knowledge that helps us capitalize on pricing inefficiencies in the market,” adds Andy Stewart, managing partner at Argosy Real Estate. He notes real estate fundamentals and values can vary block-by-block in the same neighborhood. “Therefore, a local partner who lives and breathes a specific market provides a key competitive advantage in sourcing and executing on a unique subset of opportunities,” explains Stewart.

Although complex deals would seem to be obvious areas for local partners, even core investments can benefit from asset managers who act and think like owners.

“We have found that partners who have co-invested with us on our core deals think as owners and take great pride in the performance of the property,” says Bellinger. “They care deeply about their reputation, and so they care about how the asset performs.”

Finding the right match

Investors tend to know when investing with a partner makes sense, but finding the right partner is more an art than a science. Partners can range from a local hotshot to a REIT, from a national developer to an acquisition expert in a midsize firm, from an experienced institutional player to a skilled-but-small sector-specific shop. Local partners are as different as the deals they undertake.

Unfortunately, the industry does not have a Match.com or tablet app to help separate those suitable for a long-term relationship from those who are not. Instead, investors must rely on good old-fashioned reference checking and gut instinct. Identifying a pool of local operators is not that hard. Identifying the right one is.

“Finding partners is typically a combination of a top-down and a bottom-up approach,” explains Argosy’s Butler. “In the top-down approach, we will target a particular market and asset class with strong fundamentals and then perform extensive research to find the best local operators to source opportunities and execute value-add strategies. Once an introduction is made, we stay in front of these groups and gain access to their deal flow, often making frequent trips to maintain a dialogue and to establish a level of trust with one another. From a bottom-up perspective, we review a lot of operating partners and transactions that come directly to our team.”

Homing in on the right operating partner if you are a capital provider, or a good capital provider if you are an operating partner, is one of the most imperfect processes in the industry.

“Some of it is just that it is a qualitative judgment that brings two partners together,” says Platt. “It is also the fact that, by nature, our industry tends to focus more on the bricks and mortar and less on the people. As a consequence, it can be quite difficult to identify the right management team.”

Everyone agrees skills are important, but integrity is the first and foremost quality partners look for in each other. Without trust, skills do not matter. After integrity and skills, the qualities of a good operating partner include experience in the type of deal being proposed, stable teams, financial wherewithal, and long-time experience in the market and sector in which they operate.

Operators, too, have a list of qualities they look for in a capital provider.

“A good partner provides quick feedback,” says Bryan Blake, president of Calare Properties. “They also bring a new perspective, experience or relationships outside of our core competencies and geographic area, which add to our experience.”

In addition, good partners share an alignment of interest. This typically is enhanced by each investing a specific proportion of the capital, but it also can be simply a desire to achieve a return hurdle within a shared time frame. Clear, concise communication and established expectations at inception are critical to formalizing this alignment.

“The right operating partner is one who is knowledgeable about the product type and market, sets a defined business plan, and communicates progress as well as problems,” says Deborah Harmon, CEO of Artemis Real Estate Partners. “We have a ‘no surprise’ policy internally, and the best operating partners share this philosophy.“

And then the soft qualities must be considered.

“At the end of the day, this is a relationship based on a long-term investment in each other,” says Blake. “I want to make sure there is a personal relationship. We seek partners that we not only want to do business with, but also partners that share similar values as well.”

Along with the integrity, the transparency and the general “good guy” quality needed for a successful partnership, each party needs to bring a high level of financial acumen.

“Our operating partners need to be strong fiduciaries,” says Stewart. “Just as we strive to be strong fiduciaries to our investors, we expect our operating partners to be stewards of our capital in much the same way.”

Partners, in essence, represent each other. The operating partner stands in for the capital provider when it comes to working with local authorities, vendors, and tenants. Conversely, the capital provider vouches for the operating partner to the rest of the institutional market.

“Our senior execs often jokingly ask, ‘Could this group pass the PREA test?’” says Platt. “Could you take them to PREA and survive with your dignity intact?”

Building the team

It takes a long time — sometimes years — to establish a partnership and build trust. So managers prefer long-term relationships they can rely on for several years and several deals. Despite this preference, it is possible for good teams to break in — if they have the right skills, knowledge and a bit of luck.

“Our principal challenge today is finding quality transaction flows with good risk-adjusted returns,” says Paul McEvoy, senior managing director of DRA Advisors. “We’re always looking for new partners or opportunities that make sense in markets where we haven’t been so active in the past.” McEvoy says half of DRA Advisors’ transactions are with new firms, and half are with those the firm has done business with previously. “But we will never do a one-off deal,” he adds. “We have to believe that each new partner will do a series of transactions with us over time.”

How new partners are found varies. Generally, managers target a market and seek out an appropriate partner. But it can go the other way as well. Operating groups with excellent local talent can target an appropriate manager.

“We are deluged with proposals to invest from all over the country,” says Jeff Kanne, CEO of National Real Estate Advisors. “Most of those never come to anything but, occasionally, if we get the right proposal from the right person at the right time with the right product, those requests result in a new relationship in a new market.”

New to a manager does not mean new to the industry. Most local operating teams targeted by institutional capital providers already have institutional experience. But all is not lost if a very good team is new to the institutional side.

“We’re certainly willing to coach the right people with the right experience,” says Kanne. “We will deal with someone doing it for the first time because we have our own development company that supports our developers. This allows us to provide as much oversight as needed while the local team learns what is required to perform to an institutional standard.”

Others also are willing to coach, especially if they have a focused emerging-manager strategy. But you need the resources to do that.

“For emerging managers, we have the ability to provide ‘cradle to grave’ investment- and asset-management support where needed,” says Harmon. “This support may include assistance with sourcing, underwriting, asset management, financing and disposition strategies.”

Although local operators are happy to find funding and coaching that enables them to grow and expand, it is not always easy to give up the total independence most have enjoyed. They have worked hard to build platforms worthy of an institutional manager’s attention, but it means having an outside entity looking over their shoulders.

“We do not want our operating partners to feel like they are being micromanaged,” says Stewart, “but at the same time, it is our fiduciary duty to stay close to the investment. We believe that if the operating partner feels their investment partner is adding value alongside them, then they will be increasingly motivated to keep their investment partner involved. For this reason, we believe that it is very important for our team members to have direct operational experience in the asset classes where we invest so that we can create value alongside our operating partners.”

Despite in-depth due diligence and the desire on both sides to make things work, not all partnerships succeed. A partner who turns out to be unethical can be a disaster, but very few go down that path. Instead, sometimes good people simply do not have the necessary skills, or changes in circumstance cause the partner to be misaligned with the manager.

“One of our operators grew their platform substantially over time and shifted to become more of an AUM growth-focused platform,” says Butler. “As their platform expanded, the key individuals in the firm lost their previous focus on executing on one-off, high-margin transactions, where the promoted interest was the main source of their economic motivation. Over time, we have seen this group lower their investment standards in order to increase the size of the platform and generate more fee income. This operator is no longer searching for the unique, off-market acquisitions we seek but rather responding to widely marketed deals, where it is hard to achieve opportunistic returns. Since our interests appear to no longer be aligned, it has unfortunately made it increasingly difficult for us to find common ground on new investment opportunities.”

As real estate managers and investors continue to move outside their own backyards to find good risk-adjusted returns, the world of local operators also will expand. And as more joint ventures go full circle, a compendium of best practices is sure to evolve. Yet managers, investors and operators might not need to wait for a set of best practices to be adopted. Making a partnership work might be as easy — or as hard — as listening.

“The most important skill is to listen to your partner,” says Platt. “Listen to what they mean, not just the words that they say. People often focus on structural issues when forming a joint venture, but if it is abstracted away from the human element, it is useless. Relationships that allow for change in circumstance will grow and evolve — and that’s the hallmark of a long-term partnership.”

Sheila Hopkins is a freelance writer based in Easley, S.C.