Should you invest in emerging managers?

Is it worth the risk?

Welcome back and happy Sunday!

When you’re reviewing real estate opportunities, you’ll often encounter newer GPs who are raising capital for their first few deals.

These “emerging managers” come in shapes and sizes - some might be leaving Blackstone after 20 years, others might still be in their last year of undergraduate studies.

I’ll address 5 separate topics today:

1. What separates an emerging manager from an established one

2. Pros of investing in an emerging manager

3. Cons of investing in an emerging manager

4. What to look for with emerging managers

5. Should you invest in emerging managers

Today I’d like to discuss this at length, and hope to help you form your own opinion on whether these types of investments are a good match for your investment mandate.

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First, I’ll start with a quick story. Some of you may know that I worked for a Public REIT before going out on my own (more on that experience here). The really unique aspect about this particular company was that we specifically looked for properties leased to NON investment grade tenants.

In other words, instead of buying a building leased to McDonalds or Starbucks (which are investment grade), we’d buy something leased to your favorite neighborhood furniture store or gym (i.e. a non investment grade tenant).

Now, isn’t that crazy? It’s more risk… right? It is definitely more credit risk, but it’s also more reward (as measured by cap rate, in our case) - when underwritten properly. In a sense, we (at STORE Capital) were digging in a riskier pool of tenants to carefully select ones that we wanted to partner with for the best risk-reward profile. More on the single tenant net lease business here.

Just like STORE Capital was in the business of “tenant selection,” any LP looking to invest in emerging managers is in the business of manager selection.

The question in your head should always be risk vs reward. Personally, I “parse” the analysis into 3 independent sections, which I’ve written on before and they’ll be mentioned again below:

1. Execution - track record and counterparty risk

2. Alignment of Interests - coinvest, waterfall, and fees

3. Property - valuation and business plan

With the meme behind us, let’s get to our five questions:

1. What separates an emerging manager from an established one

   1. The only acceptable answer here is track record and experience

      1. Notice that they’re not the same, and I intentionally separate the two for deals I send through www.gplpmatch.com

         1. E.g. would you rather invest with someone who has been investing on behalf of an employer for 5 years (i.e. has investing experience, but not much), or someone who has been a broker for 30 years (i.e. has been in the mix of deals for a really long time, but has never been in the principal seat themselves)? Note that both have experience, but it’s not always easy to compare the two and experience isn’t created equal

   2. At the end of the day, track record is by far the largest factor here - even if someone is experienced in real estate in general, this doesn’t mean they’ve been a principal on investments

      1. I would recommend reading Track Record Audit for more on how to vet a track record

      2. Mitigants, of course, would include if such emerging manager has handled full cycle deals for a previous employer

2. Pros of investing in an emerging manager

   1. Better economics

      1. Emerging GPs often offer stronger LP terms: higher preferred returns, better splits, lower fees. The reason is simple - their investor network isn’t deep and neither is their experience.