Behind Bain’s late arrival to the market

The timing of the private equity giant’s real estate entrance seems counterintuitive on first glance. But the firm obeys its own rule book for determining when to get involved.

Bain Capital has a rule of three when it enters any new marketplace. Before green lighting an entry, the firm first considers: one, the fit with existing platforms; two, the internal backing by senior employees; and three, the willingness to co-invest significant capital.

After decades of examining how to enter private real estate, it finally found a method that fits all three criteria: absorbing the spin-out of Harvard Management Company’s 22-person direct real estate team. Bain Real Estate will officially be born on February 1.

Conspicuously, timing is not among Bain’s three criteria. Not only does it enter the sector far later than its US private equity peers, it is also coming into the market late in the cycle, with valuations and dry power at near-record levels.

Bain Real Estate lacks a track record and third-party assets under management, making its decision to enter the fray at this point also questionable. That’s not to say HMC’s real estate team does not boast an enviable performance history. The endowment’s real estate program generated a 13.8 percent return for the fiscal year ended June 30, 2016, above its 9.4 percent benchmark, and direct real estate returned 20.2 percent in that time, according to the most recent data available. But, as many in the sector accept, split the team and the house and for both their track record starts again.

But, on the surface at least, market timing does not seem a major consideration. Emphasizing that real estate is a long-term business for the firm, Bain senior executives told PERE they want to have a team ready to invest now, rather than build a business from nothing. With capital from HMC on hand and plans to add third-party capital soon, the firm expects, both now and come a downturn, they will have the coffers to take advantage of opportunities.

Indeed, even in the current environment, Bain plans to find deals. Co-managing partner Jonathan Lavine underscored real estate head Dan Cummings’ experience investing HMC capital in cycle-defensive strategies, such as workforce housing, self-storage and senior housing – markets less prone to heated valuations than gateway cities.

Initially, Bain Real Estate’s mandate is managing HMC’s direct real estate portfolio, which comprised about 167 properties as of 30 September. But the team is mapping out the future: how to manage third-party money, where to deploy existing and future capital, and how to link with Bain’s credit and private equity platforms, as well as the staffing to execute these plans.

When it is ready to manage external capital, Bain Real Estate has no shortage of limited partners to tap: its parent counts more than 1,000 investors across products, many of which are also some of the biggest names in private real estate. That strong investor base should serve as a bulwark against a tough fundraising environment, which saw capital for US-focused private funds drop from a high of $55.4 billion in 2015 to $41.2 billion in 2017, according to PERE data. Bain is also well-positioned to follow the industry trend of offering big-ticket, cross-asset separate accounts that can now include real estate.

Bain is getting started at a cyclically high point in the market, but, by the same token, on the cusp of a possible downturn. In that regard, while timing is not explicitly part of the firm’s rule of three, perhaps it does have a part to play, after all.