As we’ve discussed previously, there are various types of real estate assets, commonly referred to as Grade A, Grade B, Grade C properties and so on.
In REPE investing, there is another well-known phrase about the quality of real estate assets in use which needs some further explanation. This is the phrase “institutional type real estate assets”, so let’s have a more detailed look at what this and what it involves.
What is institutional type real estate?
Many people tend to think of institutional real estate as only being class A properties, located in primary markets in prime locations, sometimes comprising trophy buildings with high profile tenants and occupiers—and attracting the attention of major national international investors.
Yet institutional quality real estate can be described as being a much broader class than that. In fact, such types of assets can be offices, retail, multi-family and industrial/logistics properties of grade A and B quality
However, institutional investors are increasingly also buying alternative asset types such as data centres, self-storage facilities, and accommodation for students and seniors.
Having said this, it’s actually difficult to generalise when considering exactly what institutional quality real estate is, as not every “institutional-type” investor wants the same type of property or invests the same way. Sometimes, it can be said to be the characteristic of the investor which helps determine if an asset is institutional type!
An alternative, therefore, to focussing on the physical characteristics or asset class type is to assess institutional-quality real estate on a “risk-return” spectrum. The lowest-risk, lowest investment return assets are invariably core assets such as Class A properties, with higher return, higher risk assets at the other end the spectrum (sometimes called “opportunistic” real estate acquisitions). Institutional investors will, accordingly, acquire properties along this spectrum based on their individual portfolio objectives and risk tolerance.
A further aspect to help describe institutional-quality real estate is its size and scale. Single properties may not be attractive to an institution, whereas a large portfolio, even if it contained some secondary or lower quality properties might be. One defining difference between traditional investment property and institutional-quality real estate, therefore, is scale.
Some characteristics of institutional investors
Just as there are different asset types which may appeal to an institutional investor, there are various types of such investors such as sovereign wealth funds (“SWF”), global pension funds, insurance companies or private family wealth entities
However, there are several common characteristics of institutional investors:
- amount of funds: such investors tend to have very large sums of money to invest. This fact inherently pushes institutional investors to larger-scale deals, whether a single class A asset in a prime location, investing in a REIT, or a portfolio of smaller assets which provides the investor with scale.
At the lower end of the spectrum, a private family fund might invest $30 million, whereas an insurance company a sovereign wealth fund might want to be investing $100-200 million at a minimum;
- sophistication: in terms of having a strong understanding of the risk-return spectrum, analysis techniques, market trends and outlook and how to structure deals, leverage and loans. Most institutional investors have dedicated in-house or contracted professional teams, who specialise in the various asset classes and the different phases of a deal.
As a result, typically, it’s difficult for relatively smaller investors to compete in terms of funds available and sophistication, although this is beginning to change. For example, changes to SEC regulations have made it easier for sponsors to accumulate capital from accredited investors, which is then pooled for investment into collectively larger deals.
Types of institutional investors
Just as there are many real estate asset classes, there are many types of institutional investors, including:
- sovereign wealth funds: is a private equity or pension fund which invests on behalf of a state or country and may invest in real estate projects or infrastructure, but also stocks and bonds;
- pension funds: invest large sums of pension money on behalf of states or governments or private companies, often focussing on prime city centre assets on a global or regional basis;
- private equity funds: are generally structured as a Limited Partnership with a fixed investment term of five to ten years, and provide equity financing to private entities;
- insurance companies: invest policy premiums collected from their policyholders into assets to generate returns which may be used to pay out claims to their insured;
- hedge funds are often considered as only investing in alternative investments. They use pooled funds to generate above-market returns by being willing to take on more risk than other institutional investors;
- mutual funds: are also pools of money collected from several investors for the purpose of investing in stocks, bonds or other securities but are, increasingly, willing to invest in commercial real estate;
- foundations and endowments: represent some of the most common institutional investors utilising funds from universities and large non-profit entities;
- private family wealth: entities handle investments and wealth management on behalf of extremely wealthy families, usually with $100 million ++;
- traditional commercial banks: often make investments of their own.
Some characteristics of institutional type real estate
Each of the aforementioned investor types will have a slightly different perception of what classifies as an institutional product and what does not, plus no two assets are the same and the real estate market is not homogenous.
However, broadly speaking some of the key factors include:
- security or potential security of income stream;
- attractive yield;
- quality property in prime location, leased to grade A occupiers;
- of suitable financial scale to make the investment worthwhile, bearing in mind that such investors many have hundreds of millions of $ to invest;
- prestige of holding a trophy asset;
Why invest in institutional type real estate?
In summary the key benefits of investing in institutional-type real estate include:
- good rental growth and capital appreciation prospects: if such institutional-quality assets are located in core markets, investors can expect strong rental growth and capital appreciation over time, being less susceptible to major swings over the course of multiple real estate cycles;
- depth of market: as there is a large pool of both buyers and lenders, investors can usually secure more favourable terms when acquiring or refinancing the asset. When it comes time to sell, there will be interest from both national and international buyers. In effect, this makes institutional-quality real estate inherently more liquid than other types of real estate;
- cash flow is more predictable: as many occupants are established, credit-worthy tenants holding long-term leases (perhaps from 10 to 30 years), the cash flow will be stable;
- quality tenants and rent roll: as institutional quality real estate is a Grade A product, it invariably attracts top quality tenants with strong covenants and able to sign long-term leases. Should a vacancy occur, there are usually other strong tenants wanting to occupy the space;
- quality of property: such properties tend to be either of newer construction or recently renovated, well maintained older properties. Naturally, the newer the property or if it’s in top condition, the lower the capital expenditure and maintenance costs and reduced risk of obsolescence.
How to invest in institutional type real estate
For any third party (ie not an institutional investor) looking to invest in institutional-quality real estate, the optimum route is likely to be through a syndication or fund.
It is, therefore, highly important for investors to do their due diligence on the sponsor behind such syndication or fund, checking their experience and track record.
In fact, some sponsors have strong relationships with institutional investors and are well familiar with working within the parameters set by such entity or how they may deploy, say, a value-add strategy which results in the creation of a class A asset.
In other cases, institutional investors may invest in a fund open to accredited investors so a form of co-investment may be possible. Usually, institutional investors secure a preferred equity stake and retail investors a common equity position. This co-investment type of model allows retail investors to enjoy the full spectrum of benefits which arise from institutional investing, without having to invest the same level of capital.
CPI Capital has considerable experience with both institutional type investors and the institutional types of real estate assets they prefer to acquire and operate. We also understand the broad definition of what “institutional” means when looking at assets in terms of the most suitable investment criteria.
GPs such as CPI Capital can work with institutional investors even if they tend to be oriented toward long-term investments or are not always as nimble as other investors. Naturally, given the huge amounts of funds they tend to invest, there’s usually more procedures to work through in order to obtain necessary approvals, particularly true for sovereign wealth funds and global pension funds.
Some of the key things which CPI Capital has in common with institutional investors, though, is our shared attention to detail and exhaustive due diligence on assets we review—as well, of course, as our relentless search for high quality investment grade assets!
CSO, COO, Co-Founder CPI Capital