CRE transaction volumes are at an all-time low—44% since 2020, by our estimate. Meanwhile, CBRE is forecasting a further 15% YoY drop in investment volume, and debt is becoming increasingly difficult (and expensive) to obtain. Industry experts expect underwriting standards to get more rigorous from here, likely further dampening deal-making.
As Jason Kern, President of Investment Management at Cortland, said, “Buyers smell blood in the water, looking to get some distressed deals at discounted prices. But at the same time, well-capitalized owners and sellers don't want to take a mark down where they're holding their assets on the balance sheet. And if they're not pressured into selling, you're going to have fewer sellers willing to sell into a distorted market.”
This period of “wait and see” can be seen as a challenge for groups that think of their secret sauce as doing deals, this lull creates an opportunity for operational spring cleaning, providing the time and space for managers to focus on ensuring they have the right internal infrastructure and third-party partners to take advantage of whatever comes next.
Many firms have started to outsource critical services, including fund administration
Real estate has always been comfortable with outsourcing. It’s not uncommon, for example, for a GP to outsource property management or asset management, landscaping, valuation work, environmental studies, leasing, or brokerage services. Many managers realized early on that they should focus on what they are good at, and over the past decade, GPs have further warmed to an even leaner operating model. Managers now outsource other operational services, including fund administration.
Investor demand for accountability from the private markets is only growing. LPs, particularly institutional investors whose risk management policies and controls have only become more stringent, often require a GP to hire a third-party fund administrator as a condition of their allocation.
As Managing Director Brandon Sedloff recently shared with Institutional Real Estate: Americas, working with a third-party fund administration provides numerous additional benefits, including:
Driving more transparency and accountability by having a professional third party be responsible for the official books and records for the fund;
The lowering of operating expenses and improving margins; and
Being able to allocate the cost of the administration service as a partnership expense
There’s also an emphasis on risk management, especially as high-profile fraud cases, such as the FTX scandal, dominate the headlines. LPs are increasingly looking to invest with companies that are SOC-1 compliant, meaning an outside accounting firm has tested their key financial and operational controls. Since most third-party service operators are SOC-1 compliant, GPs can benefit from partnering with them to offer their investors peace of mind.
LPs expect to access and contextualize the relationship with their GP. Technology makes it possible
From watching the packages we order from our phones get delivered on video doorbells to transferring money via an app, we’ve adapted to an age of constant transparency. LPs demand the same timely access to information about their investments, especially in a fast-paced world with ever-changing markets. According to a 2021 report by CBRE, institutions have increased allocations to real estate from 5.5% of their available capital in 2010 to 11% in 2021. The expectation is now that managers provide not only quarterly reports and documents but close to real-time information about asset-level details, fund performance information, and transactional details.
Historically, this information was shared in a basic document repository. But the right technology can power dynamic investor portals, CRMs, and reporting tools to improve communications and help internal teams focus on more high-touch investor interactions and tasks. GPs are on the front lines, and most LPs are dependent on them to know what’s happening.
Automation drives efficiency
Operational efficiency is about automating tasks that happen on a regular cadence without much variation. For fund managers, this is usually creating and sending financial statements such as capital call notices, distribution notices, and quarterly PCAP statements, along with disseminating K-1s during tax season.
Technology plays a significant role here since the best people want to be supported with the best technology that will enable them to be more efficient, reduce the time spent on mundane tasks, and allow them to focus on things they want to focus on.
Onboarding new vendors and making these operational changes is sometimes cumbersome in the short term, but the long-term benefits of getting one’s house in shape outweigh any short-term disruption.
What comes next?
No one has a crystal ball, and the will-we-won’t-we threat of recession still looms. However, absent future shocks, we expect activity to begin to rise slowly in the early part of this year. Managers who held off on fundraising late last year still have a lot of dry powder and cannot wait to go to market. The unavoidable truth is that in order to satisfy investor demand for transparency, accountability, and timely reporting, operational excellence is non-negotiable for CRE GPs. With a hard look at their service providers and tech stack, managers are wading into these waters to see if their operations are working as efficiently as possible.