Proceed with Caution

November 16, 2020

Recently, enormous focus has been placed on private investments as an asset class.  Private debt, private equity, and private real estate investments are becoming more commonplace in sophisticated as well as retail portfolios. Special purpose acquisition companies or “SPACs” have become all the rage, but these “blind fund” approaches have many challenges and should be evaluated with great caution. Similarly, one should beware of the “friends on the golf course” deals, which have their own pitfalls. Instead of investing in ‘one-off’ opportunities, consider developing a strategic approach backed by proper vetting protocols, which will help you understand the risks involved in any deal you are considering.

As a rule of thumb, following the three P’s of investment evaluation (people, process and performance) can provide a roadmap for success. The most important is understanding a sponsor and its culture before evaluating an offering. Always underwrite the sponsor and then underwrite their offering. Private investments can be very long-term investments without exit options along the way, so knowing who you’re working with and if they must have your best interest at heart, is essential. In addition, you will be wise to choose a sponsor with a focused investment strategy, avoiding those prone to distraction or errant behavior.  Evaluate the sponsor’s track record and see how well their results compared to the original proforma projections. Ask for their former investment memorandum and for communications on that investment from start to finish. Look for experienced, well capitalized sponsors, who can better weather unpredictable circumstances and do the right thing in rough patches. It is tedious to review a sponsor’s legal agreements, but the ‘devil is in the details.’ These diligence principles are fundamental to structuring a successful private investment approach.

Even when you’ve followed good diligence protocol, it is still important to diversify. You should take the time to determine how much of your portfolio should be allocated between liquid, public investments and illiquid, private investments. Within your private allocation, determine sub-allocations between growth and income-oriented areas. Most importantly, determine the appropriate sizing for each investment so you never over-invest in one deal. Maybe your goal is to have 10% of your investment worth allocated to real estate, either through several diversified funds with different vintages and approaches, or a stable of 8-12 individual properties, with a maximum investment amount per property. Whatever your individual needs, creating a framework in advance enables you to respond prudently and prevent emotional feedback from driving your decision making.

We have taken private investments very seriously throughout our firm’s history. As a result, we gained years of experience in this area long before it became a popular trend. Today, private investments are an important part of the assets we manage for our clients. Our private investment approach has always been driven by a focus on opportunities, and not by a need to find a home for dollars when the public market projections made by the Wall Street “experts” look unattractive.

Gary Martin