For a large syndicator who is constantly cycling out of deals, the idea of co-investing is fairly easy...but what about the company in growth mode who isn't cycling out of several deals per year? The question then gets dicier.
@Brian Burke posted a blog about a property he bought with no personal money in the deal...and what happened when it turned sour. Alignment of interests is much more than putting $50-100k in a deal...it's more about integrity and reputation! Unless, of course, you don't plan to be around for the long haul...
https://www.biggerpockets.com/renewsblog/colossal-fail/
Below is an excerpt from an article in Pension & Investments...
Wall Street investment firms with real estate management subsidiaries created the strategy of co-investing to coax wary investors into real estate portfolios the firms had bought through the Resolution Trust Corp., a federal program begun in 1989 to liquidate assets held by insolvent savings and loans.
The idea of shared risk with managers gave investors comfort and worked to draw them into these investments, explained Ted Leary, president of consultant Crosswater Realty Advisors, Los Angeles. Now, co-investment is de rigueur in the industry.
“It makes everybody feel better if the general partner loses money alongside the limited partner,” Mr. Leary said in an interview.
In a letter this month to clients and colleagues, Mr. Leary wrote, “I continue to see no demonstrable evidence that manager co-investment makes a manager a better investor. In fact, some of the most dramatic loss situations I dealt with involved very significant co-investment by the manager. On the other hand, several of the most successful programs I observed had minimal manager co-investment.”
Some managers have defaulted on their co-investment, consultants say, although none would name names.
“Some managers overstretched because they bought the dream that they were selling,” Franklin Templeton's Mr. Weidner said. He would not identify any firms.
Still, not all of the big managers that made large co-investments suffered lousy returns. Many held their own, even during the latest financial crisis. Warburg Pincus LLC, Madison Capital Partners and Square Mile Capital LLC all managed to return investors' capital plus some profits, insiders said.
Alignment of interests is serious business to investors. Last August, CalSTRS bought out its partners' 10% interest in four joint ventures it entered into in 2005 with First Industrial Realty Trust, a real estate investment trust.
“The move was done to achieve full control of the properties because CalSTRS felt there was not a full alignment of interest between partners,” Mr. Duran told P&I at the time.
Most institutional investors are reviewing their real estate investment strategies and how they invest in the asset class, but few are jettisoning their co-investment requirements.
“I must admit I have not won this argument with my clients and certainly not with the consultant community,” Crosswater's Mr. Leary said.
Making changes
Ernst & Young's Mr. Grinis said real estate investment managers already are making changes. Even existing funds are getting restructured to make sure interests are more aligned with investors' interests. In essence, managers of these newly realigned funds are getting paid at the end, rather than reaping fees during the life of the fund, whether the fund makes money or not. Mr. Grinis declined to name any examples.
Paul Greenwood, managing director of Northern Lights Capital Group LLC, a private equity firm that invests in asset management firms, said, "Alignment of interest ... is crucial to the long-term success and the success in providing clients with a consistently good product."
But achieving it varies with each investment, he said.
“If I'm a start-up investment manager with no personal wealth beyond what I've invested in my firm, I might have a good case for a tight alignment with my investors,” Mr. Greenwood said. “If I'm worth $100 million and I've invested $1 million in the fund, I may have alignment with my investors, maybe or maybe not.”
Glenn Shannon, president of San Francisco-based Shorenstein Realty Services LP, agrees that co-investment is not a quick fix that automatically aligns manager and investor interests. Shorenstein has committed $500 million of the $5.4 billion raised in its nine funds since 1992, but alignment of interests is more than making a co-investment, he said.
