Chasing Yield in Smaller Deals

By Steven Orchard, Senior Vice President, of Structured Finance, Transwestern: As competition remains strong for core product in top-tier markets, large institutional investors are considering alternate strategies as they search for yield.
Steven Orchard

Steven Orchard

As competition remains strong for core product in top-tier markets, large institutional investors are considering alternate strategies as they search for yield. They can typically find better returns by developing build-to-core assets for their own portfolio or buying lesserquality properties or in secondary markets. Building in primary markets has proven a popular strategy, while acquiring in secondary markets and lower-quality assets have not.

An emerging option for finding higher yield is investing in smaller deals, or those with a total capitalization of perhaps $5 to $20 million. Pricing on smaller deals can be less efficient, translating into an opportunity for disciplined bidders. For these deals, there is a larger ratio of transactions to investors, competition isn’t as fierce and the supply of capital is more modest. Traditional small-deal buyers are less consistent in their strategy, investment appetite and capital availability, providing large investors an opportunity to unearth value.

Would a large institutionally managed investor group really be willing to chase deals in the $5 to $20 million range? Yes, but only if the risk adjusted returns are compelling. Land development and constructions transactions work well, as they seed bigger projects, although standalone small-deal investments can attract institutional capital if the execution is clean and the whole dollar returns are exciting. However, the phenomenon of large investors doing small deals is thin, selective and perhaps fleeting.

There are a number of things small-deal players can do to better attract institutional capital. Institutional investors venturing outside their comfort zone will focus on relationships, so it’s crucial to develop capital relationships before they are needed. The following are suggestions to address before working with an institutional investor:

  • Tell a good story with respect to the acquisition narrative, business plan and alignment with the sponsor’s experience.
  • Perform and summarize the due diligence to make the deal easy to digest. Address and describe risks with respect to the property, market, business plan and sponsorship.
  • Don’t ask too much or grind too hard. Get a sense of market terms before presenting a request, and work toward a fair, workable relationship.
  • Make sure the business plan is fresh, targeted and purposeful. Institutional investors won’t stretch down for vanilla investments.
  • Pursue a repeatable strategy if at all possible. Investors like cookie-cutter systems since they have limited resources with which to deploy a considerable amount of capital.