Institutional investors play a pivotal role within the broader commercial real estate industry. Institutional investors, when compared to their individual counterparts, can often access and leverage significantly larger amounts of capital. The investments they make can directly influence a firm’s ability to complete projects, grow, and remain competitive.
Attempting to appeal to an institutional investor will require a much different approach than appealing to an individual. These enterprises have specific guidelines they use when making their investment decisions and are often accountable to outside stakeholders.
Typically, institutional investors look for investments that are stable, predictable, and contain a reasonably compensated level of risk. They will use large teams to make decisions, identify opportunities, and carefully construct their portfolios.
Appealing to an institutional investor is not always easy, but it is something that certainly is quite possible. Below, we will discuss some of the most important things to know about institutional investors, including their typical expectations.
What Is an Institutional Investor?
In their most simple form, an institutional investor is someone that makes investments in large enough quantities that they qualify for special treatment. This “special treatment” can include many different things, such as discounts for large securities purchases, preferential marketing during fundraising efforts, or other specific benefits.
The opposite of an “institutional” investor is a “retail” investor, which includes ordinary individuals and small-scale brokers. Retail investors can still access the same markets, but their investments won’t be as large (though they can still be very large) and they won’t qualify for the same structural benefits.
Institutional investors can make a wide range of investments, including investments in the stock market, the bond market, foreign currency (forex) market, the commercial real estate market, and many others. These individuals, needing to protect their capital, are typically risk-averse and often use relatively passive investment strategies. Nevertheless, with the right strategies, it is still very possible to attract capital from the various types of institutional investors.
What Are the Different Types of Institutional Investors?
Broadly speaking, an institutional investor is a firm that is large enough to directly affect whether an investment succeeds or fails. They are structurally large enough to make an institutional difference, which is why they sometimes get to play different roles.
Some common types of institutional investors include:
Investment Banks: These banks make large, long-term investments hoping to achieve stable asset growth and improve their bottom line.
Pension Funds: These funds have known future obligations and, as a direct result, make carefully selected investment decisions accordingly.
Mutual Funds and Hedge Funds: These funds pool the wealth of multiple non-institutional investors, hoping to meet basic earning expectations. Balancing the pursuit of returns with the avoidance of risk becomes key.
Insurance Companies: These companies look for stable, highly liquid investment opportunities. They want to generate steady returns, but they also need to be able to issue large payouts to their customers.
These are just a few of the types of institutional investors you may encounter. These investors also frequently interact with one another (and lend to each other using the LIBOR rate) and their collective actions are often coordinated.
How Do Institutional Investors Make Key Decisions?
The “best” investment decisions for an institutional investor will depend on several different factors. Most importantly, the investor will need to consider who is holding them accountable. In some cases, the people holding them accountable will be their profit-demanding shareholders. In others, it might be policyholders (for an insurance company, for example), in which case the investor will probably be more risk avoidant.
Some questions that institutional investors might ask themselves when making key decisions include:
- How much capital do I currently have to work with? How much of this capital could we potentially risk on an investment?
- How is our current portfolio distributed (in terms of asset classes)? Is our current portfolio relatively liquid?
- Would it be beneficial to diversify our current holdings?
- What is the best possible outcome we can expect from making this investment? What is the worst possible outcome?
- Have we consistently been able to meet our investors’/our stakeholders’ expectations?
- Will we be able to change, as needed?
Institutional investors will often use a blended investment strategy that features both active and passive investments. With their passive investments, the institution will play it safe, highly diversified, and put themselves in a position where they enjoy the general growth and stability of the economy as a whole. With their active investments, investors will try to find opportunities where the potential reward clearly outweighs the potential risk. Keeping the efficient market hypothesis in mind, these mismatched opportunities are rare, though they do indeed exist.
What Do Institutional Investors Expect?
Institutional investors typically have access to very large amounts of capital. Significant portions of this capital are typically held in highly liquid assets, which is why it is far from surprising that these institutions are solicited for investment opportunities on a regular basis.
If you are a relatively young company trying to appeal to these institutions for an investment, you are going to need to do some work. Here are some of the things institutional investors expect to see:
Detailed Financial Reports: At a bare minimum, your company will need to have accurate and updated versions of its balance sheet, income statement, and statement of cash flows. Tax returns and other essential financial documents will also likely be needed. Any quantifiable claim you intend to make will need to be backed up on paper.
Methods for Preventing Risk: If you are pitching a speculative project, investors will want to know what you plan to do if things go wrong. What if a project is delayed, prices increase, or other issues emerge? If you cannot answer these basic questions, institutional investors will likely pass.
Clear Path to Profit: Institutional investors are risk-averse, meaning they are not going to invest based solely on your “potential.” They will want to see that you have a plan for producing revenue and, quickly, also producing profit. Again, any claim being made should be supported with clear, honest, interpretable data.
Sustained Value: The success of any enterprise, whether in commercial real estate or any other industry, will be directly tied to its ability to create and sustain value. If you can prove how your business will have a positive bottom line, not just today, but in the future, you will have a much better chance of securing the sort of institutional investment you need.
Institutional investors operate at a large scale—they can afford to be selective. With the right approach and an understanding of their needs, you may be able to connect with the level of capital you currently demand.