Capital Revolution: How Investment Companies Took Over Real Estate

NEW YORK (TheStreet) -- In the last 20 years, investment companies have come to dominate the real estate development and investment landscape. This was not always the case.

Prior to the mid-1980s, most funding for real estate came from local investors -- usually through syndication networks and major real estate families. Insurance companies and local banks also invested, though almost always directly into a project.

Things began to change in the early 1990s, when the financial industry created new products designed to increase diversification. Publicly traded real estate investment trusts, private equity, open-ended funds and various asset-backed securities separated investors from direct ownership of real estate. While this institutionalization added efficiency and other benefits, there have also been unintended consequences.

The Rise of Investment Companies

In the late 1980s, hundreds of local savings and loan banks shuttered, resulting in what was at the time the largest real estate collapse in U.S. history, totaling more than $394 billion in assets.

The federal government took over 747 of these failed S&L banks and was left controlling thousands of loans and properties. This led to the creation of the Resolution Trust Corporation (RTC), a government-run entity intended to manage the assets and gradually sell them back to the private sector.

With thousands of assets on its balance sheet, the RTC helped spawn the new industry of asset pooling, in particular "blind pools" of real estate private equity. Not only were private equity funds well-capitalized enough to purchase these pools, they made enormous profits since the government was selling the real estate at fire sale prices.

Total Financialization of Real Estate

The industry saw enormous growth once early private equity funds had successfully proven the model. In the early 1990s, the real estate private equity landscape stood at a few billion dollars. Today, estimates show that there is at least a half trillion dollars under management.


In a separate consequence of the real estate recession of the late 1980s, most major real estate companies took their assets public on the New York Stock Exchange as REITs, resulting in a multi-billion-dollar industry.

By the early 2000s, the real estate industry had been transformed. The financial professional had become the primary manager and driver of real estate decision-making.

What Financialization Means for Neighborhoods

The financialization of real estate investment has dramatically increased the amount of capital available to developers, while simultaneously institutionalizing the industry. The major real estate investors -- from Starwood Capital Group (STWD) (the property trust company) and Blackstone (BX) to Simon Property (SPG) and Avalon Bay (AVB) -- are multi-billion-dollar players that develop in dozens of major cities.

For all the benefits of institutional real estate investment, one of the unintended consequences was to make the product more corporate. A large-scale, national investment company looks at and analyzes real estate in a very different way than a local individual investor, and this corporate mindset ultimately limits what that company builds.

Negative Consequences of Financialization

Real estate has historically been a long-term asset. However, a private equity fund or REIT usually has a near-term investment horizon. The public markets will price a REIT daily, and successful private equity rms stay in business by raising a new fund every three to ve years. The result is REITs and investment funds look at a three- to five-year period to invest and return profits.

In order to deploy hundreds of millions of dollars, investment companies gather capital from third-party sources. However, once an investment manager has pooled funds, the primary risk is generating a loss. So, too often, he or she opts to make "the safe bet," which includes a preference for corporate chains and popular asset classes and geographies.

Because investment companies operate at enormous scales, they most often are not based where they invest. Distance from projects puts an investment manager out of touch with what neighborhoods need and want. So much of real estate is focused on location, which a local person will intuitively understand better than a visitor.

Furthermore, investment companies often distill projects down to a formula (the "pro-forma"). Every real estate analyst can attest to hours spent making Microsoft Excel projections to submit to private equity partners, credit committees, or public markets. While analysis is an essential part of investment, it too often treats real estate as a product, rather than as a real, tangible place.

An Alternative Option

The flaws of corporate real estate investment have opened the door to real estate crowdfunding. Rather than a model built on middlemen pooling money, it allows real estate companies to raise capital at scale directly from individuals.

Crowdfunding creates a new capital source to fund real estate projects that may not fit in the institutional box, allowing developers to focus on the long-term success of the project and build a new kind of real estate product focused on the real end user -- you.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Dan Miller is co-founder and president of Fundrise , the country's leading real estate crowdfunding platform.

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