Advantages & Disadvantages of Investing Alongside Institutional Investors

According to Josh Herrenkohl, a Senior Managing Director at FTI Consulting, “The survey also revealed that because institutional investors have the capital and resources to play the long-term game and weather the storm created by the pandemic, real estate will continue to be a good way to manage risk and diversify their portfolios.” This is good news for investors involved with sponsors who invest alongside institutional investors.

Key Institutional Investors are Leading the Way

There are hundreds of institutional investment firms, but the key ones in the top 100 control over $20 trillion in assets. The biggest ones are pension funds, and the larger ones in the US include Federal Retirement Thrift, California Public Employees, Mercer, California State Teachers, New York City Retirement, Florida State Board, Russel Investments, and Texas Teachers. All have diversified assets, including real estate.

Factors Influencing Investment Philosophies

What differentiates one institutional investment firm from another is their investment philosophy. Most investment philosophies are based on key elements that include an overall market preference, beliefs in different asset classes, how much risk they’re willing to take, an overall management style and their position on asset diversification. Institutional investors like to have diversification across equity and debt, which helps to balance the overall risk.

Institutional investors collaborate with sponsors like myself, and one thing that I’ve experienced is that they are extremely focused on the sponsor’s experience, and they spend a lot of time and resources vetting sponsors before they invest with them. Having a successful track record in multiple projects is key to working with institutional investors. The amount of money that’s invested is another factor, as institutional investors like to write large checks, often $10M or more.

As a high net worth individual, you can find yourself investing with a sponsor alongside an institutional investor. This type of investment has advantages and disadvantages.

Disadvantages of Investing Alongside Institutional Investors

• Disadvantage #1: Preference for Funds

Institutional investors prefer large funds over single deals, due to the large checks they like to write. If a sponsor has an excellent opportunity to acquire a property but it’s only a single asset, institutional investors may pass in favor of a fund or a portfolio of properties. If you are a high net-worth individual looking to invest alongside institutional investors, you’ll need to focus on large funds or portfolio deals.

• Disadvantage #2: Risk of Cancellation

If a sponsor is counting on the institutional investor for a substantial portion of the capital, and they decide not to invest in the deal then the deal may not go through. There are many factors that can cause this, and while it doesn’t happen frequently, it can happen. As a high net-worth individual, make sure to ask the sponsor how much capital the institutional investor is allocating to the deal, and what their Plan B is in case the institutional investors decide to walk away from the deal.

Advantages of Investing Alongside Institutional Investors

• Advantage #1: You Can Rely on Institutional Investors’ Extensive Resources

Institutional investors have extensive resources, far more than any sponsor or individual group of investors. They not only have the resources and people who are able to vet a sponsor, but they also have the ability to attract high caliber sponsors due to their financial prowess. Their resources go beyond vetting a sponsor. Due to their size and experience, they also have the ability to fully vet a specific market as well as a specific deal. As a high net-worth investor, this provides another layer of security for passive investors, as the institutional investors have deep resources to ensure that both the sponsor and the deal are properly vetted.

• Advantage #2: Access to More Investment Opportunities

Thanks to institutional investors’ size and their large amount of investment capital, they are often able to secure access to investment opportunities that are simply not available to private investors. Institutional investors can also access a variety of investment instruments not available to private investors. By working with a sponsor who invests alongside institutional investors, high net-worth individuals can gain access to these investment opportunities.

Summary

Due to the pandemic, 2020 was a volatile year for investors, including institutional investors. But current surveys show that there is a lot of optimism for 2021, particularly in the real estate asset arena. Institutional investors include venture capital firms, hedge funds, insurance companies and other large financial entities, who often have a diversified portfolio that include stocks, real estate properties, and other investments.

They are very focused on the sponsor’s experience and have the depth and resources to vet a sponsor, a specific market, and a specific deal. This offers an additional layer of security for limited partners who are able to invest with sponsors that also invest alongside institutional investors.

There are many advantages to investing alongside institutional investors, including access to many of the top deals not available to limited partners and the extensive knowledge and resources that they bring to the table. The disadvantages include their preference for funds over individual deals, and the risk of cancelling a deal if the institutional investor chooses to back out of the deal for any reason.