For some real estate investment management firms, the phrase “the bigger the better” does not apply.
This week, Trion Properties, a Los Angeles-based private real estate firm, announced the launch of its second fund, which aims to raise $50 million. It is dwarfed by the mega-funds of the private real estate sector’s heavyweight managers, like Blackstone and Brookfield Asset Management. However, Trion, which has reported an average internal rate of return of more than 30 percent for non-fund deals since 2005, has benefited from the small size of its assets along with their short hold period, Trion managing partner Max Sharkansky told PERE.
Micro assets – defined as properties acquired at less than $10 million – outperform macro assets, yielding an 8.76 percent higher internal rate of return than assets larger than $10 million, according to a recent Washington University study. The study used data from 1,025 office and industrial real estate transactions from 1993 to 2016.
Missouri-based Bamboo Equity Partners, which assisted Washington University in the study, exclusively pursues these micro deals through its $20 million Micro Opportunity Fund I. Transactions of micro assets are harder to track. Even data providers like Real Capital Analytics seldom report on such small deals, and one consequence of that is a less liquid market that the firm can take advantage of, Bamboo Equity managing principal Dan Dokovic told PERE. In a less liquid market, assets are more difficult to price, giving Bamboo Equity an opportunity to acquire undervalued assets while facing less competition, according to Dokovic.
Smaller assets, fewer problems.
“Returns diminish with size,” New York-based firm Arel Capital managing partner Richard Leibovitch told PERE. “When you get into these mega billion-dollar funds and billion-dollar deals, returns tend to suffer. With large size comes large problems.”
What are the problems with larger deals? Large acquisitions can be difficult to execute, while the fees associated with those transactions tend to cost more, according to Leibovitch. He believes most major players in the field face challenges putting capital to work and may be buying large assets at a premium. Arel Capital’s own investors tend to like smaller deals struck via smaller funds because it gives them a higher level of control, he said. Arel Capital’s strategy focuses on acquiring mid-sized $50 million-$150 million multifamily rental properties.
However, “one size does not fit all,” according to Alexandra Krystalogianni, head of research at Allianz Real Estate – the real estate platform of German Insurance giant Allianz, which is a prolific buyer of larger commercial properties. Firms with larger pools of capital may want to seek out larger assets since it can be a more efficient way of deploying capital. As an institutional investor with large amounts of capital, Allianz does not consider the definition of “micro,” under $10 million, and “macro,” over $10 million, as being relevant. A $200 million US office is a better example of what it would consider a “large” asset, Krystalogianni told PERE. On the other hand, smaller investors may want to stay away from large assets, which can bring concentration risk and result in a less diversified portfolio, she noted.
For a firm that raises larger funds, investing in micro assets can take up nearly as much time as investing in larger deals. Consequently, it is often more efficient to pursue larger assets if the amount of due diligence being done is the same, Dan Mahoney, senior vice president of research and strategy at Chicago-based real estate investment manager LaSalle Investment Management told PERE. While some smaller properties may offer higher return prospects, they tend to be more volatile, which in turn comes with additional risk, he argued.
Mahoney also observed that micro assets only account for 1.2 percent of market value invested in real estate in the NCREIF Property Index, which means outperformance or underperformance by these $1 million-$10 million properties would not significantly drive portfolio performance in most cases.
Ultimately, whether micro-assets make sense or not depends on the amount of capital involved. Like many things, the answer lies in the realm of relativity.