Family Offices and PropTech
We already talked about one class of investors: Corporate VC firms.
Let’s talk about family offices for a minute.
At a high level, these are obvious investors for CRE Tech or Proptech. If they have any size at all ($500M+), they will certainly hold a decent amount of commercial property within their “alternatives” portfolio (as opposed to the stocks/”equity” and bonds/”fixed income” that make up the majority of the remainder of their investable capital).
Generally speaking, allocation theory states you should have about 10% of your investable assets in alternatives. Really, it ranges from 5% to 15% depending on several factors, but let’s use 10% for a round number. So, a $500M family office should own about $50M of alternatives.
Traditionally, commercial real estate has taken the lion’s share of that 10% and that hasn’t changed much. What has changed in the last year or so is that allocations to CRE are feeling a little too heavy. Most major firms and investors have been investing aggressively in CRE since 2011 or 2012 and the returns have been robust. That is all starting to change since real estate prices have been “healthy” (as opposed to “depressed” in 2011 and 2012) and most firms and funds are running out of clever CRE strategies because the pricing of the properties is too high.
So, most family offices are looking for clever ways to invest in alternatives and they do not need more commercial real estate strategies. Most FOs have also watched the rise of Venture Capital as a viable asset class inside of their alternatives portfolio. I don’t have time to get into it here, but just take my word for it that along with Pensions, Endowments, and SWFs, family offices have realized that exposure to venture capital is the new normal for a healthy portfolio.
Given those two trends, more (if not all) family offices are looking at venture aggressively in 2019.
Now, VC can be a bit intimidating as a first time investment. It’s viewed as the most risky asset class (“but 90% of startups fail” etc.) and most institutional fund managers like Kleiner Perkins, Andreessen Horowitz Sequoia Capital et. al have decades-old relationships with other investors who regularly write them $25M to $50M checks for the next fund.
So, as much as they may want it, most FOs will not have access to the top tier VC firms. The next best option is to find a niche in VC they understand or can influence. Sometimes that’s a geography (“even if all these startups fail, at least we supported the Denver tech ecosystem”) or a niche they already know well . . .
Like . . .
Real Estate! (look how smart you are!)
As has been well-documented, the rise in the CRE VC firm has been remarkable in the last five years. Family Offices now have several options for investment in the space that span stage, geography, and niche (say, Construction vs CRE or Multifamily vs all Property types).
So, if you read the news and can do some basic math around allocations, you’ve probably decided it’s worth you time to consider an investment in PropTech.
Where to start?
To dig in a little deeper, much like we did with CVCs, we need to make the world of investors a little more manageable by breaking family offices into two groups: Single Family Offices (SFOs) and Multifamily Offices (MFOs).
Let’s start with SFOs.
A Single Family Office is just an investment platform run by professionals that handles the assets of a single family (or maybe a couple, but not many). The LeFraks and Rudins fall into this camp (and have both been active in PropTech).
SFOs are notable because they are typically pretty flexible and can be aggressive when they need to be. That should be obvious since there is only one family to please and (generally . . . hopefully) they decide things quickly. They can be flexible on terms and timing. The opposite is also true. They can be deadlocked for years if siblings/cousins disagree. They are not formal or rigid and that cuts both ways as an investor. It’s fair to say that SFOs can be both the best investors in an LP pool and also the worst because of their lack of infrastructure.
If that’s you, I’d recommend avoiding direct investments depending on your size.
As a rule, don’t invest into deals directly unless you allocate capital for ten deals or more. It’s just the simple math of a 90% failure rate in startups. If you can’t invest in ten startups in a niche you know well (AgTech, MarTech, PropTech, whatever), then you should NOT invest directly in startups as an investment strategy.
You are welcome to do so as part of your philanthropic strategy. Just don’t expect any of that capital to be returned because the math just doesn’t work.
If you want the capital returned, funds are your only (mathematical) option if you can’t afford to do ten deals. As I said above, unless you manage $1B+ you probably won’t get access to the top-tier mega funds.
Think about it. If Sequoia is raising $2B fund, they can’t take $5M checks from investors. That would be 400 investors to manage. That would be stupid. They will have a fund minimum that is $25M to $50M.
Backing into the math, if you allocate 2% of your portfolio to venture, that means you would need to have a total investable pool of capital that is at least $1.25B to justify a $25M fund investment.
And, keep in mind, that would be the entirety of your venture allocations. No other funds. No other theses. No other geography. Just that one. Hope you like that thesis . . .
More likely than not, you will need to find smaller, emerging managers.
Good news — There are plenty.
Bad news — You will have to do some diligence on them.
I get back to the age old wisdom of invest in what you know and where you can influence the outcome. For most families who built wealth via real estate and construction, that means PropTech. You’ll understand the problems being solved and be able to implement them in your CRE portfolio.
This is not really anything new. This is the exact reason you see an entrepreneur have a big exit with his MarTech company and then make a large LP investment in an emerging MarTech fund. She gets the process and the tech. Another young man sells his CPG company for $1B and then, surprise surprise, invests in a CPG Tech fund.
Nothing new here. It’s just time the CRE and construction wealth figured out that this formula has worked well for decades.
On to the Multifamily Offices or MFOs.
These are family offices that pool the assets of multiple families and therefore have to create formal underwriting and credit criteria since the families don’t always agree on everything.
That’s why I lump these family offices in with Wealth Management and Registered Investment Advisory firms. They have formal diligence processes and specific annual allocations to funds.
Because of that, I’m not sure I have much to tell this group other than — be thoughtful about your emerging manager strategy.
It’s not really controversial (or surprising) that first and second time funds outperform more senior, legacy funds.
I know you can get into the bigger, more pedigreed funds because of your size (MFOs are generally bigger than SFOs) and I would invest in those too. But don’t act like the risk-adjusted-returns for those earlier stage funds aren’t compelling.
They are. And you know it.
And I’ll tell you the same thing I said to the SFOs, go where you have knowledge and control. If your major families are CRE and construction wealth, Proptech needs to be on the menu. Since all of the Proptech fund managers qualify as “Emerging” this would be a thoughtful (and justifiable) space to wade into slightly riskier waters!
I know you won’t be in a first close.
Wait until everyone else cleans up the terms and PPM and sidecars and then bring your $10M. But then you don’t get to complain about terms or inflexibility or lack of co-investment rights. That’s for the first guys through the wall.
You are term-takers not term-makers.
Find a manager or two you like, track them, and then hop into that second close before your spot gets taken by someone more decisive.
That’s all I got for the family office crowd. If you need specifics or want an unvarnished opinion on a fund or strategy, hit me up — MKnight@blkhwk.com