Expanding the Concept of Institutional Quality Real Estate
The term “institutional quality” in real estate traditionally conjures images of high-quality, Class A properties located in core markets—think of a prime office building in Manhattan, a luxury high-rise apartment in Los Angeles, or a cutting-edge lab building in downtown Boston. Generally, this term refers to properties of sufficient size and stature to attract large national or international investors, such as pension funds, insurance companies, endowments, and REITs.
However, in 2024, this definition is evolving. The commercial real estate market is as competitive as ever, and institutional-quality assets in core markets are increasingly out of reach for many investors due to soaring prices and compressed cap rates – or unappealing to those who are looking for a higher return on investment. As a result, forward-thinking investors are broadening their horizons, focusing not just on the type of property or its location, but also on the “institutional quality” of the sponsor behind the deal.
The Role of Sponsors in Institutional Quality Investments
A commercial real estate sponsor is a key player who finds opportunities, lines up capital, oversees improvements, and manages a project through to stabilization. The sponsor’s expertise and track record are crucial to the success of a deal, making the quality of the sponsor a defining factor in what constitutes an institutional quality investment.
Increasingly, we’re seeing experienced sponsors who have left institutional investment firms to start their own companies. These sponsors, having honed their skills managing billions of dollars in commercial real estate, bring an institutional quality approach to projects that may not traditionally be considered “institutional quality” by property type or market location.
These sponsors often focus on Class B or Class C properties in secondary or tertiary markets – areas typically overlooked by larger institutional investors. These markets are now attracting attention due to their lower entry costs and higher cap rates. According to recent data, cap rates in secondary markets can range from 5.0% to 6.5%, compared to 4.0% to 4.5% in primary markets. This spread provides an attractive risk-adjusted return for sponsors – particularly those who are able to acquire an asset from a mom-and-pop owner, implement institutional operations and then exit to an institutional buyer.
Institutional Investment Strategies in a Changing Market
Institutional investors have historically preferred low-risk, high-return investments, often avoiding excessive risk to preserve capital. However, the sheer volume of capital they need to deploy means they cannot afford to examine every opportunity, particularly smaller deals that require just as much due diligence as larger ones. As a result, these investors often stick to larger projects in major cities, where higher property values align with their investment mandates.
On the other hand, sponsors who have transitioned from institutional roles to entrepreneurial ventures are not constrained by the same limitations. They can apply institutional investment strategies to smaller, overlooked markets, focusing on wealth preservation while still identifying value-add opportunities or deals that fly under the radar of institutional private equity. For example, small to middle market multifamily and senior housing are sectors where this approach has been particularly effective given the smaller deal sizes.
Multifamily Housing: In 2024, multifamily properties in growing secondary markets are seeing strong demand due to ongoing housing shortages. The national vacancy rate remains low at approximately 5.5% to 6.25%, while rental rates continue to see modest increases at around 1% to 2% annually, primarily driven by a combination of strong demand and limited new supply in many markets. Prior to the current rate tightening cycle, investors were increasingly targeting value-add opportunities in this sector, where they can upgrade older properties to capture rent growth and increase property values. As we enter a rate easing cycle, it’s likely that more value-add buyers will re-enter the market. At Alpha Investing, our preferred multifamily strategy is HFC tax abatement deals where we partner with a local housing finance corporation to reserve about 50% of a property for middle income tenants – receiving a significant property tax abatement in return.
Senior Housing: Similarly, the senior housing sector, including assisted living and memory care facilities, offers substantial growth potential. With the senior population set to increase significantly over the next decade, demand for senior housing is projected to grow at a compound annual growth rate (CAGR) of 5.5%. Industry-wide occupancy rates have rebounded to over 83% in 2024, reflecting the growing need for these specialized housing options. Alpha Investing’s senior housing portfolio with Titan SenQuest (includes independent living, assisted living, and memory care) is just over 90% occupied as of Q2 2024. Sponsors focusing on senior housing assets in secondary and tertiary markets can uncover opportunities for favorable basis acquisitions and repositioning of existing properties, capitalizing on demographic trends that drive long-term demand.
Institutional Strategies Applied to Smaller Markets
Sponsors coming from the institutional world bring a wealth of experience and relationships, allowing them to employ sophisticated acquisition and disposition strategies even in smaller markets. For example, they might acquire a portfolio of value-add properties in the same geography, improve and stabilize them, and then sell the entire portfolio as a larger package to an institutional investor. This approach can command a premium over selling individual assets and demonstrates how institutional strategies can be successfully applied to non-core markets. Alpha Investing believes this strategy will be particularly compelling in the senior housing asset class, where a stabilized portfolio would provide an attractive investment opportunity for an institutional investor looking to create a steady stream of cash flow for its limited partners.
Moreover, institutional investors are increasingly recognizing the value of partnering with sponsors who operate in these smaller markets. By providing the majority of the capital for such deals, institutional investors can tap into the expertise of sponsors while gaining exposure to markets that offer higher returns than the overcrowded primary markets.
Conclusion
While traditional institutional quality real estate remains in high demand, taking a broader view can help investors diversify their portfolios and uncover new opportunities. By focusing on the quality of the sponsor and extending proven investment strategies to secondary and tertiary markets, investors can achieve the same wealth preservation focus that defines institutional investing while accessing markets and properties that were previously overlooked. In 2024, this broader definition of institutional quality real estate is opening doors to investment opportunities that combine stability with the potential for significant returns.