United States

Mid-market real estate PE strategies could pay off in major markets

Equity funds are amassing capital but running out of places to put it.


Across the US, equity funds are amassing capital but running out of places to put it. The consensus says that the best large deals have already been made in the large, coastal American markets, and even many of the secondary markets have been picked over.

As the primary market for the American Midwest, Chicago has not been immune from these issues. The largest equity players, whose funds run into the tens of billions, often restrict themselves to glitzier coastal markets, where they can be sure demand will stay high. Meanwhile, Chicago’s assets have grown too richly priced for many smaller equity shops, which are looking for greener pastures within a family of up-and-coming cities across the Midwest.

However, a deep local knowledge of assets, entitlements and neighborhoods can help small and large players alike source the right deals in Chicago and the non-coastal markets in the U.S.

“Chicago doesn’t get the love that the coasts get,” RSM Real Estate Senior Analyst Laura Dietzel said. “It’s hard to say exactly who’s winning in Chicago equity, because so many smaller investors are shifting their focus to secondary and tertiary markets.”

Chicago-based funds have slowed their growth. In 2018, 27 funds were closed in the city of Chicago, with a total size of $8.5B. And though 23 funds have closed so far in 2019, their size has been chopped to $3.6B.

That slowdown reflects a growing consensus among investors that U.S. assets have become too richly priced across the board. With economic and political uncertainty plaguing global markets, Dietzel said, many foreign investment companies see the U.S. as a safe haven. That demand has propped up asset values across the major American equity markets.

But while investors still seem to be willing to pay a frothy price for the safety of an office building in Manhattan, that faith has not always extended to Chicago. Though the city has its fair share of deals ripe for the taking, Dietzel said, large investors are still put off by local uncertainties, including the state’s pension crisis and a new assessor who is trying to overhaul property taxes in the city.

Smaller equity players are looking to markets smaller than the Windy City.

“For a lot of the funds I interact with, it’s difficult to invest in Chicago,” said Tom Green, assurance lead at RSM’s national real estate practice. “For some smaller funds sponsors with capital raises of $100M to $500M, it can be difficult to compete against the larger funds and go after the quality core assets. It's too expensive and too large of a concentration.”

These smaller funds, for which coastal markets are not approachable, are increasingly looking for developing economies to deploy their capital. Green said small and midsized funds have seen strong interest in the nation’s emerging tech centers, including Nashville, Denver, Austin and Columbus. Land, labor and goods are cheaper in these cities than in coastal markets. Cost of living is low compared to the coasts, and demographics support business growth, with populations booming and local companies retaining college graduates.

States with business-friendly policies are also becoming strong markets for smaller equity players. As companies flee states with high corporate taxes such as California and New York, states like Texas and Florida have been only too happy to catch them. Dietzel added Dallas-Fort Worth, San Antonio, Tampa, Fort Lauderdale and Orlando to the list of markets that seem ripe for investment based on their business demographics.

In all of these markets, local expertise will trump any macroeconomic trend, she said. Having a deep knowledge of local practices and neighborhoods can give smaller equity players an edge.

“Technology has given us the ability to understand markets and trends, but it’s the local touch that gets deals done,” Dietzel said. “The small shops may actually have the upper hand in places like Seattle or the Bay Area, because entitlements in those markets can be a nightmare and they’re willing and able to put boots on the ground.”

Small shops may also be able to nab projects that large equity players have decided to throw away. Dietzel described how a huge private equity player like Blackstone might acquire a whole swath of assets, then weed out deals that don’t make sense one by one.

“Maybe it’s not part of Blackstone’s overall strategy, but it’s right up the alley of a local player,” she said. “It’s crucial to have an area of expertise to differentiate yourself as a small firm, so you can snap those deals up.”

These same small-market strategies could also pay off in Chicago. As a native Chicagoan, Green said he has seen numerous projects have success by working with local communities to secure approvals and raise enthusiasm about investment and development in their areas.

“Chicagoans want to know that a developer knows them and has their interests at heart,” Green said. “Diversity and inclusion have become huge. Investors need to make an effort to reflect the ethnic and cultural background of the markets they work in. Chicago is a beautiful city, and it’s done a great job to renew itself, and make itself attractive for tourism and business."

Green said that despite the fact that Chicago investment has slowed, he still has a positive outlook for the city as a whole.

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This article was originally published in partnership with Bisnow.


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