Takeaways From Katten’s Presentation on Alternative Real Estate Investment Strategies for Family Offices

On March 10, Katten Real Estate Senior Counsel Alvin Katz and Timothy Little joined guest speakers from Focus and Dwight Mortgage Trust to discuss alternative real estate investment strategies for family offices. Their presentation explored two different strategies — one that allows investors to partner directly with developers, and another to form debt platform partnerships — and also examined how those deals are structured, key risks investors should consider and the critical negotiation points that can make or break those partnerships.

Family offices seeking real estate investments have traditionally relied on private equity funds or non-traded real estate investment trusts (REITs), which typically charge both an annual management fee and take a percentage of profits. While these funds can be a valuable part of a diversified real estate investment portfolio, they can lack transparency and involve layers of fees that dilute ultimate returns. One alternative to investing in a fund is sponsor equity or co-general partner (co-GP) investing, which allows a family office to invest directly alongside a real estate developer as a partner, rather than as a passive investor in a larger fund. This approach enables the investor to select a specific project (or strategy) and developer, and share in the developer's profit participation; it can yield substantially higher returns, albeit with substantially higher risk.

The co-GP investment structure typically involves a family office contributing some percentage (often a majority) of a developer's required capital, with the developer contributing the remainder. In exchange, the investor receives a proportional share of the return earned on contributed capital plus a portion of the developer's "promote" distributions — the disproportionate share of profits a developer receives once capital (and some minimum “hurdle” return) has been returned to all of the investors in a deal. The timing of this co-GP investment significantly affects risk and return: an investor entering early in the process, before permits and approvals are secured, takes on more risk but can negotiate for a larger share of the promote distributions, while one investing later, after financing is arranged and construction is ready to begin, should expect to receive a smaller share of the promote distributions in exchange for undertaking reduced risk. 

A co-GP investor should carefully consider several key factors. These investments focus on a single project without diversification, and poor project performance can result in loss of principal. The investor has no control over exit timing and must rely entirely on the developer's execution capabilities. The strategy works best for an investor with a long-term capital horizon and a tolerance for illiquidity, given that development projects can take several years from initial approvals to full occupancy. An investor considering co-GP investing should also consider whether to participate in project guarantees, which may entitle it to a share of development fees and enhanced promote sharing, as well as ensure the investor's interest is aligned with the developer on borrowing levels, risk management and the timing of project sale. 

Another alternative strategy involves partnering with an established lending platform to invest in commercial real estate debt rather than equity. High interest rates and distress across most real estate asset classes post-COVID have reduced yields on many private equity funds while simultaneously increasing potential returns on debt investments, which are repaid before equity investors and thus carry lower risk. A family office can structure these partnerships as a true joint venture (with the lending platform contributing a portion of the required funds and handling day-to-day operations), a fee-based arrangement (where loans are transferred to an investor-owned entity but administered or “serviced” by the lending platform) or a hybrid arrangement. Similar to co-GP equity investments, these debt joint ventures offer flexibility, allowing the investor to negotiate decision-making authority and the types of loans to be made, such as construction loans or short-term bridge loans, as well as approval rights over individual loans and control rights when borrowers default. 

Key negotiation points for these debt strategies include defining the type of acceptable investments, establishing investor approval rights over individual deals, allocating opportunities among the lending platform's various capital sources and determining the duration of the venture (including negotiating removal and exit rights, and addressing what happens to existing loans or investments upon termination of the venture). The investor’s level of sophistication often shapes these negotiations, as lending platforms seek partners who can rely on their know-how and track record while still bringing a meaningful investment amount and a long-term relationship mindset.

Whether pursuing co-GP equity or debt platform partnerships, family offices can avoid the layered fees built into many fund structures, achieve greater transparency in their investments and customize their investments to match their specific goals and risk tolerance.

Hosted by Katten Real Estate Senior Counsel Alvin Katz and Timothy Little, panelists included Tim Anderson, CEO & Founder, Focus; Vicky G. Lee, Executive Vice President, Capital Markets and Investments, Focus; and Chris Baker, Head of Capital Markets, Dwight Mortgage Trust.