Private real estate investment funds with a diversified portfolio can’t put all their eggs in one basket, no matter how promising a property’s future looks. However, for some investors, the additional risk and potential reward of riding a shotgun in a sidecar are worth it.
Fund management makes sidecar investments available when a high-quality asset is discovered, but its price exceeds the fund’s property budget. They don’t want to pass up a fantastic chance, so they recruit other people to invest with them. The fund’s management conducts the due diligence necessary to acquire a property and then determines whether or not individual investors wish to co-invest with the fund. Sidecars are driven by the fund’s interest in the asset, as opposed to syndications, which are co-investments between a sponsor and a group of investors.
If a property is awarded at $25 million, but the fund only allows $15 million to be spent on any one asset. The fund’s investors provide the remaining $10 million in equity through a new sidecar entity, which is funded by $15 million from the fund’s existing capital commitments.
Like the fund manager, investors make sidecar investments to capitalize on a lucrative opportunity. This partnership model is not novel, but it is becoming increasingly prevalent as private equity real estate funds and high-net-worth investors work together to grow their holdings.
Sidecars are Designed for Speed in Private Real Estate Transactions
Sidecar investment vehicles allow asset managers to quickly secure financial commitments, which can be critical in negotiations. This investment allows them to complete the purchase without giving a particular property undue weight in the fund’s portfolio, minimizing its idiosyncratic risk. They can also structure the transaction with less reliance on loans, lowering the deal’s leverage risk.
When private real estate funds provide sidecar investments, investors are called individually and invited to co-invest, with the option to say yes or no to contribute more equity. Sidecar commitments are often distributed among prospective investors on a first-come, first-served basis, or based on their proportional involvement in the fund, to ensure that the opportunity is transparent and equitable.
The investor’s relationship with a trusted co-investor serves as the fuel for a sidecar. Investors benefit from the experience and judgment of an asset manager who shares their investment philosophy and business interests. The idea that sidecar investors can benefit from the extensive underwriting and due diligence asset managers put into reviewing the deal is appealing to many. The opportunity is presented to the investor without the need for additional investigation, and the fund sponsor covers the majority of the legal and accounting fees associated with the transaction. Previous experience will have proved that the investor and fund management are already on the same page in terms of investment strategy, with the added benefit of obtaining the first refusal on properties from a proven trustworthy source in previous dealings.
The sidecar concept was popularized by Harvard economist Richard Zeckhauser, who saw sidecars as a way to benefit from the particular skill that some people have in sourcing investments, such as the early Berkshire Hathaway stockholders who invested alongside Warren Buffett. Zeckhauser used the motorcycle sidecar rider as a metaphor. Above all, the investor must trust the driver.
The Role of Sidecars in Investment Firms
When their asset allocations aren’t quite enough to pay the entire cost of an acquisition, investment firms offer sidecars on a small number of purchases annually for strong bids for their Qualified Opportunity Zone Fund.
Suppose the fund manager offers different conditions to co-investors or brings in persons who do not participate in the underlying fund. In that case, there is an inherent conflict of interest with sidecar arrangements. This is why some investment firms only accept contributions from existing investors for its sidecars on a first come, first served basis and why these investments go fast. Some asset managers may not be looking out for the best interests of their fund clients when they bring in third parties to invest alongside them.
Co-investment opportunities in sidecars can pique investors’ interest in a private real estate fund, and once they’re in, they can kick back and enjoy the trip.
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