How Institutions and Individuals See Real Estate Differently

By: Brian D. Milovich, Managing Principal, Calvera Partners

One Property, Two Views

There’s a wide chasm between the way institutional investors and individual investors think. One isn’t necessarily better than the other. Both ways produce successful investors, but they rarely align. I’ve been on both sides.

The Institutional Way of Thinking

Many institutional investors have a strict, data-driven approach to evaluating real estate. They rely on historical rent growth rates, rent growth projections from data providers like Yardi or RealPage, historical exit cap rates, and detailed comps. In-house construction managers separately inspect properties and provide an assessment of the needed capital budget over the investment period. Once there’s internal buy-in on the assumptions (both financial and capital expenditures), the deal is run through a complex waterfall to determine the net return to the company. In essence, every single assumption must be backed up, and that impacts the underwritten returns.

After multiple layers of fees and increasingly conservative assumptions during investment committee discussions, the projected returns usually don’t look as good. This becomes the downside case. An upside case asks, “what if?” What if rents grow faster? What if cap rates compress? While this scenario shows stronger returns, the investment decision is ultimately based on the downside case. At times, investment committee can feel like a process of finding reasons not to do the deal instead of finding ways to move forward. Downside protection is paramount to institutional investors, because fundraising is always top of mind.

Individual Investors Aren’t All Cowboys

Individual investors get a bad rap. To institutions, they’re cowboys—1031-driven, return agnostic, or unsophisticated. While individuals don’t typically ask a tenth of the questions institutions do, that doesn’t mean they skip due diligence. They just have different motivations and sources of capital.

Take the wealthy tech employee in Silicon Valley who hit it big at Nvidia and sees exorbitant single-family home prices. They might develop an investment thesis targeting small apartment buildings. They’re likely highly intelligent (they do work at a successful tech company) and can handle real estate math (it’s not hard). Though they might rely on the sales broker or their lender for their first deal, they’ll develop their own system going forward.

Individual investors usually buy with their own capital. They don’t have external investors. Many don’t care about IRR or investment multiples. Some focus on annual cash flow, while others don’t care about cash flow at all and bet on long-term appreciation because they bought at a good basis. Some are tax-focused, looking for a property to generate depreciation after running out of enough depreciation on others. Then there are 1031 flippers who only care about the dollar profit and rolling into larger assets as quickly as possible.

But don’t mistake these different motivations as an excuse to do bad deals. These individuals didn’t get where they are by acquiring just any old property. They have preferences for specific submarkets and deal sizes. They have strong banking relationships, which allow for quick execution and competitive loan terms. They often have established management teams that run smaller buildings a specific way—to maximize their goals, not an investor’s.

Combining the Best of Both

Ideally, you underwrite like an institutional investor but operate with the instinct and efficiency of an individual investor. These traits are hard to combine, but sometimes a deal arises that makes the combination easier. We’re under contract on one such deal now. It was marketed to institutional investors because it’s a three-property portfolio, but the way to maximize value is by selling the properties individually to smaller investors.

Let’s ignore the seller’s motivations for going the institutional sales route and focus on this unique opportunity. Institutional investors (we tend to think like one) want to vet every line item, prepare for every contingency, and make sure the capital budget covers all maintenance risks. If they see elevated historical expenses, they’ll ask, “how can we operate any cheaper than they did?” When institutions look at a deal under this lens, the valuation decreases.

Individuals would evaluate each property independently. Some might already own nearby buildings and can share maintenance or leasing staffing. Others have preferred vendors who can do the same landscaping work for less. Perhaps they self-manage and won’t underwrite a management fee. Ultimately, the individual investor will underwrite to lower expenses and justify a higher price. And as I mentioned earlier, some might have strategic or personal reasons to pay top dollar.

In our case, we believe we’re getting the best of both. We can fully capitalize a vintage property, address key maintenance concerns, and buy at a lower purchase price—while having the option to exit to individual buyers at likely higher valuations. I would argue that we don’t need to do every capital project to produce a profit, but by doing so we can eliminate buyer concerns, broaden our buyer pool, and increase the odds of a strong exit.