A Game of Musical Chairs

Or so those in the real estate investment management sector must be feeling.  As the music has stopped, are there sufficient chairs? The extraordinary rise of the institutional investor in real estate for the past twenty plus years spawned an equivalent rise in the number of real estate investment managers of

Or so those in the real estate investment management sector must be feeling.  As the music has stopped, are there sufficient chairs?

The extraordinary rise of the institutional investor in real estate for the past twenty plus years spawned an equivalent rise in the number of real estate investment managers of all sizes and types: equity, debt (whole loan and securitized), securities, international, sector specific, geography specific, etc.  Now we see a precipitous drop in the level of new capital to be provided by such institutions as they face issues of liquidity, and consequently we may well see a corresponding reduction in the sector that serves them.

We categorize today several classes of investment managers: those that are large, international and subject to foreign institution and government issues; those that are large/midsized domestic and international, but independent, owned either by private equity platforms or entrepreneurial participants; and finally, those that are small, independent and entrepreneurially owned.

We are entering a period of account transfers.  We are entering a period of “zombie” managers, i.e. those that cannot raise and invest capital on a go forward basis.  We are entering a period of consolidation, which will be a difficult process of transfer.  The landscape of providers may look materially different over the next five years (as it did after the commercial real estate breakdown of the early 1990s).

What will characterize the survivors? 

1.    Certainly a minimum “size” or Assets Under Management, allowing for financial flexibility and the ability to retain and hire the best human capital during these difficult portfolio times.
2.    The ability to fund future co-investment and therefore invest institutional capital, if raised.
3.    An enterprise that is managed with good, if not best practices versus simply serving as a “deal shop.”  We will see both the enterprise-based model and the deal-based model, but the latter will have core aspects of strong enterprise management.
4.    Teams of managers that are “rowing” together versus the stress that we see developing between teams of managers.  Breakdown in the leadership of managers is the surest way to bring down an enterprise.
5.    Leadership that can hold and motivate both senior and mid-level managers.
6.    Compensation programs that motivate appropriate behaviors relating to both the investor and the enterprise versus simply a participation in deal or fund pieces.
7.    Enterprises that are creative and willing to diversify and grow in order to gain market share (in a declining pie, the strategy of market share is imperative).
8.    The ability to bring on the best human capital that the market has to offer.
9.    For many who fundamentally understand the psychology of the investor and are able to shift/diversify into controlled accounts, club accounts and related structures that require a different style of management and investor interaction.  Organizations may require changes to their human capital, processes and procedures and rewards system to address such opportunities.

The game of musical chairs will be a stressful one and will result in a changed landscape, but those who understand how the game is changing and are prepared to manage an enterprise with strong practices will find a way not only to survive, but prosper.

— An Enterprise Perspective from FPL Associates