To start, we realize that our opinion is biased based on the fact that we are a private equity firm focused on commercial real estate and we would obviously love to work with you as one of our investors, but the reality is that not all PE firms are a good fit for every investor based on a number of factors. Fortunately, you as the investor have a huge opportunity to significantly increase returns on commercial real estate investments right now as this asset is doing extremely well.
In this article, we’ll guide you through a number of considerations you should make when evaluating a private equity firm to invest with (that includes our firm, CRE Income Fund).
How to Evaluating a Private Equity Firm
The first thing you’ll want to do as an investor is evaluating the private equity firm as just that, a firm. Assessing overall how the firm conducts business, how it performs in general, how they invest, its biggest wins, losses, etc. are all important factors to consider before going deeper into the relationship process with a PE firm.
Are you going to like working with them? And will you feel confident in your choice?
Here we’ll break down areas of consideration you should look at based on the fact that you are entrusting the firm to be the lead as your transaction sponsor with the responsibility of finding deals, analyzing them, managing them, and generating high performance.
- Track Record & Experience – Good PE firms typically have considerable experience with a particular type of property they invest in, as well as a long history of high and stable performance. They of course should be asked how long they have been in business, what the average tenure of the team is and how their performance is when compared to alternative investments.
- “Skin in the Game” Investing Their Own Money – Partners and Managing Directors who invest their own money in their deals should be taken as a sign that they believe in the outcome of the opportunity. Ask if leadership at the PE firm is also investing their own money alongside their investors.
- Structure of Compensation – How does the private equity firm get compensated? Is it based on property performance or does the bulk of the firm’s revenue come from fees? The financial incentives of PE firms and their investors must be aligned across all deals to encourage strong performance.
- What Makes the Firm Different – There are many investment firms that focus on commercial real estate. And while they all generally do the same thing, the approach can differ significantly on some very important points related to how and what they invest in. Ask the firm what sets them apart from its competitors to get a better understanding of what those differentiators are.
- The Firm’s Approach to Underwriting – Before purchasing a property/investment, such firm must have the deal underwritten, which forecasts income and expenses over a multi-year holding period. This means the firm has to make certain assumptions about things like revenue growth and vacancy. These assumptions can have a significant impact on the overall investment performance. Ask potential commercial real estate PE firms you are evaluating about their underwriting approach and whether their pro forma assumptions are conservative and based on verifiable data.
- What is their Best & Worst Deal – Firms mainly love to promote their biggest wins, but it can also be insightful to ask about deals that didn’t go as planned. Ask the PE firms about their best and worst deals as well as the lessons they’ve learned from them.
What To Do After You’ve Found a PE Firm You Like
Once you have identified a firm that feels right based on your qualifying evaluation, it’s important to go deeper by looking at the active deals the firm is managing now and/or upcoming projects that will be deployed as a part of your investment with that firm.
Here we break down how to evaluate those deals to ensure you are making the right decision in your choice of who to invest with.
- Evaluate Active & Upcoming Deals – Every investment proposition is slightly different and there is no “right” or “wrong” option; Rather, investors should seek to work with a PE firm whose deals are consistent and align with your investment objectives.
- Evaluate the Structure of the Deal – The legal structure of a deal can have a significant impact on the opportunity, cash flow as well as ownership between the private capital company and investors. Ask about how these deals are structured.
- Fee Evaluation – PE firms invest a significant amount of time and financial resources upfront to prepare a deal for presentation to investors. This time and resources add up in many cases to high costs. To cover those costs many firms charge fees. You as the investor want to ensure these fees are used to cover administrative costs while the majority of the manager’s profit should come from investment performance.
After going through each of these steps in the evaluation process, you as an investor will be fully informed and have everything you need to determine which private equity firm will suit your individual needs.
As a PE firm focused on commercial real estate, we would love to be on your list of considerations and welcome a conversation to give you the information you need about our firm and how it may fit into your investment strategy.
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