PREA: Cutting out the middleman

The trend of institutional investors going direct with local operators is now starting to catch on in emerging markets.

After years of investing in real estate funds focused on emerging market, more institutional investors are looking to go direct in these regions.

In Brazil, a strong indication of this intent to do direct deals is the recent opening of local offices in the country by sovereign wealth funds such as GIC Private Limited and pension plans such as the Canada Pension Plan Investment Board, according to Máximo Lima, co-founder of HSI Investimentos, a São Paulo-based real estate fund manager.  Having on-the-ground teams enables the institutions to bypass the so-called capital allocators – which often rely on local operating partners to source and execute deals – and access those operators directly.

Allocator firms typically charge investors fees on behalf of their own firm as well as the operating partner. Going straight to the local firm thereby removes this double fee structure for an investor.

“I think you’re going to see them trying to do directs themselves, and they’re certainly starting to try to cut out the middleman that way,” Lima said, speaking at the Pension Real Estate Association conference in Los Angeles last week. “That’s a trend that’s taking off.”

For firms such as HSI, which do the vast majority of the development, construction and property management work in-house, the shift to direct investments in Brazil won’t have much of an impact on business, Lima noted. However, such a transition may be of concern to allocator firms, which potentially could lose clients to the local operators.

Meanwhile, Parry Singh, co-founder and senior managing director at Red Fort Capital, an India-focused private equity real estate firm, noted that some sovereign wealth funds that had invested with the manager’s first or second funds now were seeking to invest directly in the country. He noted that pan-India strategies haven’t been successful for even the largest Indian developers and that more focused geographic market strategies work better. “It’s better to do certain pockets of the market if you want to do direct because a whole country is very difficult,” he said.

Singh added that the biggest risk in investing in India is the bureaucracy. “I don’t think it’s manageable by somebody who parachutes into the country,” he said.  In this respect, it’s an advantage for an investor to work with a local operator. “It’s very important that in every geography there’s somebody who specializes.”

Singh predicted that, as the real estate market in India grows, institutional investors increasingly should be able to make direct investments. “I see this as a natural evolution. I would just warn people to be cautious of the risks.”