Why So Much Private Equity is Shifting to Multifamily

HUNTINGTON BEACH, CA—Private-equity investors like the strong cash-on-cash that multifamily can provide as compared to hotels, retail and office properties, panelists at the IMN Multifamily Forum here tell attendees.

HUNTINGTON BEACH, CA—Private-equity investors like the strong cash-on-cash that multifamily can provide as compared to hotels, retail and office properties, panelists at the IMN Multifamily Forum here told attendees Thursday. Moderated by CBRE vice chairman Brian Eisendrath, he session “Working With Institutional Capital” discussed the mindset of institutional investors and how to play to your strengths with this sector.

Jerry Fink, managing partner of the Bascom Group LLC, said typically private equity has invested in hotels, retail and office properties, but this sector likes the strong cash-on-cash that multifamily can provide. “The cap rates are in the 3.5-point range, and the overall returns are lower than with commercial properties.”

Multifamily has always been a part of what UNC Management Co. does, said Rodgers Harshbarger, director of private investments for the firm. “Relative to other property types, the variance in terms of skill sets of operators is much wider in multifamily, and it’s getting more operationally intensive as time goes on. There are always going to be opportunities for above-average operators to take over; there’s lots more underperforming going on.”

When Eisendrath asked what the ideal profile of a deal for institutional capital might look like, Noah Hochman, senior managing director of TruAmerica Multifamily LLC, said “Multifamily is priced to perfection, but private equity is looking at alternatives. Multifamily has a much more compelling risk/return profile than the other classes. We find a lot of people searching for yield, but it depends on the comfort zone deal by deal. Private equity is very finicky; it changes its mind frequently. Certain deals in secondary markets might not get a white-shoe investor.”

Fink said some of the challenges of working with private-equity investors are that they are looking for a “unicorn” in a sea of “ordinary” deals. “They want off-market, distressed, with no equity brokers involved and a high IRR on the model, in coastal California with 9-foot ceilings.” The reality is that they may find a property in a blue-collar area that’s less attractive but the right deal for them. Fink added that return expectations aren’t dropping among private-equity investors, and they feel they shouldn’t have to pay acquisition fees on a listed deal.

Harshbarger said when working with private equity, “we say, ‘What are you trying to solve for and I’ll tell you how to pull the lever.’”

In comparing core-plus investors to value-add investors, Hochman said the two are basically chasing after the same deal these days. Keith Rosenthal, president and CEO of Phoenix Realty Group, said there are certain core-plus versus value-add deals where the differences are small and some where the differences are large. “To me, core-plus is paying more, so they’re taking more basis risk; it’s not a fixer-upper, so there should be a 10-year, closed-end format. Newer-vintage properties have less exposure to cash-flow risk, so it’s not as much of a gray area” as Hochman is saying.

Eisendrath asked about the courting process for private equity, and Hochman said, “It’s a combination of a relationships business and having a platform that speaks for itself. Usually, after the first deal, it’s easier.”

Fink said it takes a long time to build a strong partnership. “You have to show them a deal and keep showing them deals—it won’t happen right away; you have to nurture the relationship. It’s a long courting process.”

When discussing whether to raise a fund for investment or go with an equity partner, “Fundraising is hard. I’d rather be rich off management fees” than raise a fund. Matthew Levy, VP investments for the Laramar Group LLC, said, “We distinguish ourselves with small urban infill rather than jumping into the pool for class A. We focus on smaller buildings,” which diminishes the need to fundraise. Fink agreed that it’s “very hard and time-consuming to set up a fund—and it’s expensive—but it’s nice to say the capital is in the bank” when bidding on an asset.