August 4, 2014
Interviewed by: Privcap
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GPs: Ignore Retail Investors At Your Peril

Real estate GPs who ignore the capital raising power of retail investors do so at their own peril, according to David Lynn, author and former head of portfolio management at Cole Real Estate Investments.

Real estate GPs who ignore the capital raising power of retail investors do so at their own peril, according to David Lynn, author and former head of portfolio management at Cole Real Estate Investments.

GPs: Ignore Retail Investors at Your Peril

With David Lynn, Author and Former Head of Portfolio Management

Zoe Hughes, PrivcapRE: I’m joined here by industry veteran David Lynn, formerly of Core Real Estate Investments and Clarion Partners. Thank you so much for joining me today.

David Lynn, Author, Former Head of Portfolio Management: My pleasure, Zoe.

Hughes: We all talk about capital flows within real estate and where the next wave of capital is set to come from. The shift in the pension world away from defined benefit systems toward defined contributions could have a significant impact for commercial real estate and alternatives, generally. What do you see happening? When will this change come and will it have a big impact?

Lynn: It’s a seismic shift that’s been occurring for decades, so it’s not recent. These public pension funds are completely unsustainable at every level—city, county, state, and federal.

It’s been about the growth of 401(k) and defined contributions since the ‘80s, accelerating in the downturn when a lot of these government pension plans just throw their hands up and say, “We can’t do this. We need to renegotiate.” Going forward, for new employees, it’s rare that you get into a defined benefit plan.

Hughes: From conversations I’ve had, there seems to be a fear that these wealth advisors advising the defined contribution plans won’t look at alternatives. It’s just too risky, with too many liabilities.

Lynn: It’s been easier and more comfortable to be in fixed income. There has always been a sleeve for alternatives and that seems to be growing now for a couple of reasons.

In the downturn, portfolios were hit hard and part of that was the volatility we saw, particularly in equities. Alternatives have a real place in terms of lowering volatility, but more important is the need for higher income, more durable income, and alternatives. Some alternatives, particularly real estate, fit the bill very well.

If you talked to most wealth advisors, they’re telling you, “It’s my intention to increase allocations for real estate. I’m not sure how to do it, and I’ve got a good public REIT allocation, but I probably have enough of that. I need more private equity.” So, we need to step up to the challenge in some private equity firms, like Carlyle, KKR, and Blackstone are doing just that. They’re reaching out, providing vehicles, envelopes, and environments for the wealth advisor and the direct retail investor. So, it’s really happening.

Hughes: For the wider GP community, particularly for private equity real estate, should they be paying attention to this change?

Lynn: Absolutely, and you ignore it at your peril. As I see it now, there are two big trends in terms of new capital or capital coming in to alternatives in real estate.

One is foreign capital. I’ve seen a huge ramp up, particularly from Asia and Europe in the U.S. The U.S. is a very attractive real estate market.

The other is this huge retail pot of money, which has been there, but only marginally accessed by some players (non-traded REITs, for one) and a few private equity players here. But, now you have a change in regulation allowing direct outreach on the part of private equity to the retail consumer.

Hughes: There are huge challenges in reaching out to the retail investors. Liquidity is a big issue, like daily NAV. What do you see as some of the biggest challenges to tapping that retail investment?

Lynn: Absolutely great questions. We need to educate first and foremost that it’s a different asset class. It’s not going to behave like stocks or bonds, and it won’t be completely liquid when it comes to private equity real estate. It’s a long duration asset class. Don’t expect to have a great return within the first six months or year. It’s more like four to seven years, minimum.

We need to do a much better job of getting out there in all forms of media. I’ve written a book recently called The Advisor’s Guide to Commercial Real Estate Investment, with the intention to provide a baseline of information to the advisor community to do exactly that. Here is this asset class. Here is how it behaves. Here is how it works in the portfolio. Here is why it’s very attractive for you. Here are the modalities of it. Here is how you can actually invest. We need to do a lot more in that area.

Hughes: How do you handle the distribution network?

Lynn: Already there are more fee-based advisors than commission-based advisors. Of course, the commission-based advisors get a healthy fee, 7% to 10% or more. I don’t think that’s sustainable long term. What will happen is what happened in the mutual fund industry in the 1970s. Mutual funds were charging commissions of 7% to 11% and now they’re just a tiny fraction of that; they’re basis points.

I think the same will happen in our industry. When you look at the universe of the commission base, they’re actually the minority, and they’re shrinking.

Hughes: In tapping the retail investor, where is their risk appetite?

Lynn: They tend to be more risk-averse. There still is a negative connotation about real estate, to be utterly frank. Part of that is painted by the brush from residential real estate and what happened there in that collapse. But there is not a lot of knowledge and understanding about real estate, hence more education.

They’re not so concerned about the big bogie, so if you tell them you’ll get a 20%-plus, it doesn’t resonate. They think, “I don’t believe that. It’ll never happen.” It sounds like escape the 1980s, “No way am I going to get into that!”

They’re not that interested, by and large, in value-add and opportunistic and development strategies. They really want some value right now—to buy into existing value and existing income. They’re very happy with a current income of 5% to 8%. They’re happy with that and a total return anywhere from 8% to 12%.

 

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