How Co-Investments Work

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Brian D. Milovich

Managing Principal, Calvera Partners

At Calvera, we invest in apartment buildings through discretionary investment funds. That’s a fancy way of saying we receive capital from numerous investors, aggregate it into one large basket of investment capital, and then we invest it in the right properties, based on a pre-approved strategy. Investors like this structure because it gives them diversification into multiple properties and geographies. We like this structure because the sales market knows we have the capital to make a purchase and are a strong buyer. Sometimes, though, investors really like a particular deal that we’re acquiring for the fund, and they want more of it. To accommodate those investors, we have offered the ability to co-invest alongside the fund to our fund investors only—no outside investors—so that they have extra exposure to that single asset. 

Why would someone do this if they’re already invested in that property through the larger investment fund? There are many reasons investors will do this, and it has proven so popular among our investor base that we were oversubscribed by almost 50% for our most recent co-investment opportunity. Here are a few reasons: 

More Control: In a discretionary fund, investors do not have any say in whether or not we acquire a particular property. We outline the strategy for the fund in advance, as well as the general business plan for the assets, and we execute on that directive. For a co-investment, the power is in the hands of the investor. They can decide if they want more exposure and by how much. From our perspective, it’s a vote of confidence that we purchased the right property when there’s great demand for a co-investment. 

Single Deal Exposure: Depending on how much someone invests in a co-investment, they may be seeking to super-charge their investment. Some people even make fund investments to get access to co-investment opportunities. In a co-investment, they can invest a larger dollar amount, sometimes at more advantageous terms, and take a targeted stake in a particular property. While they appreciate the diversification and potentially reduced beta (i.e., risk) of a portfolio fund investment, the perceived alpha (i.e., extra return) from a singular targeted investment is interesting. Some investors believe this trade-off is worth it to take on the additional risk of concentrating an investment in a single asset. 

Tax Differences: The Calvera Income and Growth Fund is structured to own properties in a REIT subsidiary so that our fund investors receive income taxed mostly at either the dividend rate or classified as a return of capital to further minimize taxability. However, some investors who own real estate outside of Calvera may want the losses that real estate can generate. In that instance, a larger position in a co-investment can give those investors taxable losses (not generated at the fund level) in order to offset their taxable income elsewhere. 

There is also the question from investors of why do a co-investment at all? If it’s good enough for the fund, don’t dilute the fund’s returns by sharing the investment with another set of investors. This is a valid concern, and it generally comes down to portfolio construction. If a fund has $50 million in equity, but there’s a great deal that needs $25 million of equity, should a fund manager place 50% of the fund in a single transaction? That’s hardly diversification, even if it’s a screaming deal, and likely not what the investors signed up for. In this instance, it makes sense to bring the fund’s exposure down to a more manageable level. Our funds also have concentration limits (i.e., no more than 25% of the fund’s equity can be invested in one deal) so that we don’t add undue exposure to our investors. The co-investment option allows us to maintain the diversification benefit of the fund while enabling investors the option to get additional exposure in deals they find especially attractive. Additionally, by only allowing investors already in the fund with access to the co-investment, we ensure that no outside party is receiving preferential treatment. In this way, co-investments can make sense for both the investor and the fund manager. 

We are always looking to provide additional value to our investors. The first time we offered co-investments in a deal was for a property we purchased in Austin, Texas three years ago. After we closed on the purchase, we asked our existing investors if they wanted more of it and the demand from investors was enthusiastic. On every acquisition with a larger capital need, we now offer a co-investment to get the fund’s equity in line with diversification goals. By doing this, we attempt to construct the best possible portfolio of properties for our funds. Co-investments allow us to do both , and are an important part of Calvera’s capital deployment strategy 

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