Back in 2008, right before the Great Financial Crisis, I was fortuitous enough to sell my entire real estate portfolio and was brought in by the board of directors to East West Bank to assist them with their non-performing loans. As my time there wound to a close, having worked on over a billion dollars of notes, I met with Goodwin Gaw of Gaw Capital, a visionary Hong Kong Chinese billionaire investor with an outstanding reputation. And Goodwin asked me to leave the bank to run one of his funds.
Well, it was in working for Gaw Capital that I really learned what institutional investing was and how institutional investors operate. Today, in the world of real estate crowdfunding, the term "institutional" is often used - but what does it mean exactly? Learn the definitive answer to this question in today's episode with Mike Hu, Managing Director at Gaw Capital Advisors, USA.
What You're Going to Learn
Characteristics of Institutional Quality Real Estate
Scale and Size of Asset Classes in Institutional Quality Real Estate
Types of Investments that Institutional Quality Real Estate Investors Prefer
Categories of Investors that Invest in Institutional Quality Real Estate
Understanding a Sophisticated Institutional Real Estate Investor
Preparing for the First Meeting with a Potential Institutional Real Estate Investor
Introduction to Finalizing Paperwork on Institutional Real Estate Investment
Legal Due Diligence with Institutional Real Estate Investments
What Institutional Investors Want to Know about the General Partner (GP)
Timeline to Finalize Institutional Real Estate Investment Deals
Biggest Risks in Institutional Real Estate Investing
Types of Investments that Institutional Quality Real Estate Investors Prefer
ADAM GOWER: What will those investors, what will be the key drivers for them? Security, yield, prestige, like what's really driving their motivation?
MIKE HU: Yeah, no, it's a good question. It's a combination. I mean, depending on the investor, whether it's a sovereign wealth fund investor to global pension funds, endowments, foundations. From our experience and from my experience, I would say, generally speaking, the largest investors are a little more gravitated because a lot of them, it may not be, it's not domestic capital. It's not in the US. So, if it's a sovereign wealth fund from Asia, the Middle East or Europe, they'll be more focused on the key gateway cities, if they're investing in the United States. So like, in the US, they're less likely to buy a building in Kansas City versus New York City or San Francisco or Chicago or L.A. So, I think there's a bit of a preference from, if I'm generalizing, from non-US investors to buy in key gateway cities in the US and that tends to be bigger assets because most of these investors are investing large amounts of capital. They can't invest in small deals. So like, generally speaking, most of these investors, they won't even look at a deal if the equity is less than $100 million dollars. Like that, it's not even, it doesn't make any sense. And they're also 892 investors, which gives them a tax benefit.
ADAM GOWER: What's an 892 investor?
MIKE HU: These are these are applied to sovereign wealth fund investors. So, if they invest into real estate and own less than 50 percent, they basically don't pay any taxes. So, it's a huge advantage for some of these international investors to invest in real estate, but not own a majority stake.
Categories of Investors that Invest in Institutional Quality Real Estate
ADAM GOWER: Explain to me what is an institutional real estate investor. You've talked about sovereign wealth funds, but what other categories of institutional investors are there, that you deal with?
MIKE HU: Yeah, so the key categories, I think are, sovereign wealth funds. So these are self-explanatory, but basically countries, and whether it's the excess reserves that they manage or a pension fund on behalf of the country. This capital is often used to invest into real estate and other asset types around the world, from private equity to infrastructure, equities and fixed income. But they are a significant investor in the private equity space. There are endowments and foundations. So think, sort of, your top universities and nonprofits. There are a number of prominent ones that we work with. They're very sophisticated investors. You have global pension funds. So, large US pension funds across the United States, in Europe, Asia, the Middle East. Those groups are all very sophisticated investors. And, I think the key thing about institutions and actually, sorry, the last bucket I excluded was family offices. I think large family office investors, they are, I view them as being very institutional because they're doing the same thing that you would see, like, an endowment or foundation do. They may or may not be, obviously depends on the family office, so family offices, like, are investing, you know, smaller check sizes and not doing co-investments and direct deals. And then there's a number of large family offices that have a very significant real estate program and are doing a number of these deals directly. So, I would say those are, the sort of, the main buckets that make up institutional investors and those are the type of investors that we work with at Gaw.
Introduction to Finalizing Paperwork on Institutional Real Estate Investment
ADAM GOWER: But let's get back to the way that a negotiation looks and what I'm getting at here is how you actually get to the finish line. So with this new investor, there is a fairly formalized ritual by which you get to know each other, Q&A, and meetings, and et cetera, et cetera. And then there comes the point where you are pushing across the table, a pitch, right? Invest in this fund, or we have a building we'd like you to take a look at, et cetera. Describe that process. How do you now navigate to the close with somebody like that? What does that process look like?
MIKE HU: So, it totally depends on the investor. I've had meetings with some investors that have gone out of their way to seek me out or the firm out, and they have said, I want to learn more about Gaw Capital and your Gateway fund, for example, the Pan Asia Fund or the US fund. And they've reached out to us, even through like, a cold email and just said, I'd love to, I'd be interested in getting to know you. I work for X, Y, Z organization and it's a notable organization. It's very obvious that they are genuine. They're reaching out and so, we'll have a conversation, and I would say the process ranges from meeting them, usually doing some sort of on site meeting and due diligence from access to a data room, for sort of, desktop DD to ultimately on site DD in our office. So, that investor and or their consultant, especially large US pension funds engage in a consultant and do due diligence on their behalf. And they will do investment level due diligence. They'll also do, sometimes, operational due diligence, which is ODD, and that means reviewing the back of the house. So, understanding how the finance and accounting works, capital calls, distributions, what are the risk and compliance protocols in place, and that's something that most institutional managers like a Gaw Capital, like we're going to be very familiar with it because that's the part that most people don't really talk about, because it's, sort of, the less sexy side of the business, I would say, compared to the, sort of, the investment side where people, you just have to have that. It's sort of a given. Every investor expects that you do that really well.
ADAM GOWER: That's the admin. You're talking about the administration side of things, right?
MIKE HU: That's right. And so, and going back to the process. So you go through that and then at the end of, sort of a due diligence period, that investor goes through usually an investment committee process to approve the investment. Once that's done or along with that time period when that is approved, you enter into legal documentation. And so then, you're negotiating the LPA, or Limited Partnership Agreement to side letters to other other legal docs that are required, and then they're completing a subscription booklet and to finalize the investment.
Legal Due Diligence with Institutional Real Estate Investments
ADAM GOWER: So, there's a couple of things you talked about there that are very interesting. One, you used the term consultants and then you used the term, legal documents. Both of these basically speak to outside professionals being brought in as part of the negotiation that you put together when you're trying to close a deal with somebody. So just tell me about. What that looks like, again, with a new investor. Presumably you put a contract in front of them and then what? Their team of lawyers will respond to that and then your lawyers will respond to theirs. Just describe that process at little bit and the reason I'm asking you is, as obvious as it may seem to you Mike that that's what people do, is it isn't that obvious, actually, in the world of crowdfunding. So do drill down, if you don't mind, just a little on what it looks like to have consultants involved and lawyers when you're going through this process.
MIKE HU: Yeah, I mean, so the consultants... it's really dependent on the investor. Not all investors use consultants. Some, and they use consultants to different degrees. Some rely on consultants and will not make an investment without a consultant's approval. Other investors use the consultant to augment their own due diligence. Others will have them only focus on certain parts, whether it be the ODD or investment DD portion or on-site DD or whatever it is like. It may be just a small portion and then some just say, we don't use consultants, we just do it all in-house. And, they have a team that is capable of doing the investment themselves and underwriting themselves. The legal due diligence or the legal documentation is the back and forth, typically between our lawyers and their lawyers, along with business counterparts like myself and the investor would ultimately join for the business points. There are different, sort of, hot buttons, I would say that people will touch on. But, it really depends on the investor and it depends on how specific they are with certain legal requirements. Some, like legally, are not able to invest in certain spaces or geographies, etc. and they'll just say, look, we can't do it. We have to have a carve out for that. Others will just say we have a preference, for example, for leverage to be lower or whatever and I'm making examples up like, they could say something and you either choose to accommodate it or you don't. And as the manager, as the GP, if you don't want to agree to that, you have to be willing to potentially lose that investor because that investor and not all investors, as you know, will just, sort of, sign the docs and sort of, take it or leave it type situation. And that's quite different when you're dealing with this sort of negotiation process.
What Institutional Investors Want to Know about the General Partner (GP)
ADAM GOWER: Ok, so what do institutional investors look for in a GP? When they're looking to invest, presumably in the same way as you're looking for investors or talking to investors on a daily basis, investors are looking at GPs on a daily basis. So, what are they looking for and how do they make sure what they see is what they're going to get?
MIKE HU: Yeah, it's a good question. I think they're really looking for GPs with a good track record and with a strategy that they can underwrite and understand. They're focused on, sort of, the best names and I think that's what people are focused on when they're meeting with different managers.
ADAM GOWER: So, that was, again, you did blip out briefly, but let me just paraphrase. So a good track record and also in alignment with their investment strategy. And so how do they determine that you have a great track record? You say, look, here's our presentation. It's more than just. Oh, that's nice. Yes, great. We're satisfied now, isn't it? Tell me a little bit more about what they really do.
MIKE HU: Yeah, so they want to see your track record in terms of like, what are all the deals that you've done and what's the performance of those deals? Right. So assuming you sold some of those, you will have harvested and you'll have some returns that you can show. If you haven't sold them, They'll want to see what are the mark-to-market returns and or projected returns. So, that's what they're looking at. When they're looking at their track record, at someone's track record. They basically are saying, show us everything that you've done to date because we want to know your good deals and your bad deals.
ADAM GOWER: Really? And then, will they ask for references? Will they visit sites? I mean, how do they verify what you're telling them is true?
MIKE HU: Yeah, they'll do both of those.
Timeline to Finalize Institutional Real Estate Investment Deals
ADAM GOWER: So how long is the process then, on average? I know there's going to be a range. But, from the first contact with an investor that calls. You make first contact, to closing the first deal with them, you figure?
MIKE HU: I mean, we've done it... I would say.. It could be as quick as two months, like two to three months would be, sort of, I would say warp speed and then there's some investors honestly, like there are some investors that, I'm not exaggerating. There are some investors that we've closed and we've been able to get into one of the Gaw funds or vehicles that we've been speaking to for 10 years.
Biggest Risks in Institutional Real Estate Investing
ADAM GOWER: So what are the biggest risks in institutional investing, both from an investor and a GP perspective?
MIKE HU: Yeah, I think that from a GP's perspective, the biggest risk, which is a risk but also can work as both a plus or a minus, is the investors that are long, long-term type investors, usually have long-term patient capital, however, there are some things that can impact a long-term investor to have them make short-term decisions. So, for example, right now, let's say, like during March, when the equity markets were in a free fall. As the equity markets drop, that actually decreases the equity portfolio. It's called the denominator effect, but it basically decreases their equity portfolio, increases the value of their real estate portfolio and that goes above a certain threshold for an institutional pension fund or an institutional investor that has a certain allocation where they need to stay within that window. They may be forced to sell certain assets during that time period, which may be the wrong time to be selling. And that is something that could negatively impact you as a GP because they could have to sell certain assets that they don't want to sell at that moment in time. I think that the negative for the institutional investor is that I think that they can't, they're not always as nimble. There's usually more bureaucracy. If you're talking about, like a pension fund or a sovereign, they're just not like an endowment or foundation or family office where maybe it's like a single principal that just makes a decision and says we're investing in that deal. It's quite different. So I think that that sort of nimbleness and also probably going back to when you were saying scale, like they're not going to be typically investing in 5-10 million dollar deals because it's not worth their time - it takes the same amount of work as investing into one hundred million dollar deal. So, that's sort of the drawback.
