Real estate investors are increasingly embracing co-investment opportunities, but the many that are still not following this path typically cite the same practical challenges as reasons precluding them.
More than a third – 37 percent – of investors polled for the PERE Perspectives 2020 Survey say they plan to participate in co-investment opportunities in the next 12 months, up from 31 percent in last year’s survey. However, a greater share of investors are unsure about their co-investment activity in 2020–21 percent, compared with 16 percent in 2019.
“Co-investments continue to be opportunities that a lot of investors are interested in, often as a way of lowering their overall fees, because co-investments often have lower fees and carry,” says Matt Posthuma, a real estate funds partner at the global law firm Ropes & Gray.
Lower fees are not the only attraction of co-investments. It also offers investors more control over the make-up of their portfolio and can help them get to know managers better – it can facilitate, for example, a clearer understanding of the way a manager works and underwrites transactions.
The level of interest in co-investment in the private real estate asset class continues to be lower than in private equity, where 59 percent of investors polled reported they are planning to make co-investments in the next 12 months.
The hindrance factors
The speed required to conclude a transaction is the biggest factor cited by investor respondents for hindering their participation in co-investing.
“From the sponsor perspective, when there’s a co-investment opportunity, they want to be able to move quickly,” Posthuma says. “They don’t want to have to survey all the 30 or 40 investors in their funds to see whether they are interested in providing capital.”
The second most cited factor – the fact that the investor may not be staffed adequately to participate in a co-investment – is closely linked to the first. As a result of the need for speed in co-investments, there’s a natural selection that takes place and that often favors larger institutional investors.
“Most of the time, those interested in co-investments are the largest investors,” says Posthuma. “They have bigger staff and are more able to evaluate opportunities and act fairly quickly. The smaller shops really don’t. They may have just one real estate person. It’s harder for small investors to really evaluate co-investments in the time that’s needed.”
Co-investments can also lead to greater concentrations of capital in an investor’s portfolio. Nevertheless, some large pension plans including the California State Teachers’ Retirement System, which has $254 billion in assets under management, and the Teacher Retirement System of Texas, which has $153 billion in assets under management, have used co-investments over the past year to increase their exposure to real estate. To circumvent the practical hurdles, some pension plans interested in co-investments have made formal co-investment commitments to funds which are not binding, but which speed up the process once an opportunity arises.
“The reason they want to do that, is it takes away at least one layer of approvals internally,” says Posthuma. “Now they don’t have to go to their investment committee to approve that deal.”