Is it time for LPs to go pencils down?

Welcome back and happy Sunday!

I get asked two questions on nearly ~every podcast/conference I get invited to:

• Should LPs be pencils down?

• What’s your favorite property type currently?

The truth is that both of these are extremely related, and today I’d like to explore how I’d answer both and why their relationship is critical to serious LPs.

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I wrote a bit about my prior experience working for a REIT here, and I’d recommend reading that before you continue so that you can understand how I think about risk/reward.

At the end of the day, ~no LP should be interested in investing in a deal if the projected returns are similar to what one can get in treasuries. By extension, the same is likely true if the return is comparable to the long-range 7-9% average of public markets (which, by the way, also offer liquidity in a way that private markets don’t).

So why do we do LP investments? The biggest answers that come to mind are pretty simple:

• Search for addition return (I’d say at least 10% IRR, otherwise why bother)

• Diversification from your other assets

• Enjoy the analysis aspect and like to learn about investments - more on this topic here as the only reason for investing less than $100k

Now let’s return to our two questions:

• Should LPs be pencils down?

• What’s your favorite property type currently?

Should LPs be pencils down?

My opinion here is an unequivocal no - you should never be pencils down. I’d give you two reasons for that:

• When everyone is pencils “up” the market is flooded with capital and is typically overheated; when people are thinking about being pencils down (aka nowadays) there a much higher chance of finding capital dislocation (fancy way of saying good deals not finding their capital)

• Purely from an educational standpoint, you’ll learn just as much (perhaps more) during times when many aren’t in the market. And let me be clear - this doesn’t mean that you should invest, it simply means you’re observing, asking questions, and learning… but are ready to invest when the right opportunity strikes

“Ok, maybe I shouldn’t be pencils down ... but I’m not liquid currently so what’s the point?”

Fair, so perhaps you don’t look at as many deals, but keep in mind that it usually takes months to ramp up once you’re liquid. It’s much better to get familiar slowly than forcing yourself to a short period in time with no context of the past.

“I don’t have time for this”

That’s a great point, and if you don’t … I’ll be the first to tell you don’t do it. If you don’t have time to learn how to invest property, you should likely not be investing (somewhat controversial opinion with more on the topic here, but I don’t know why - this isn’t a casino). But you also have to understand that when you do have time, don’t expect to deploy cash immediately. If you have a little bit of time, I’d get started early so that you can develop the “investing muscles.”

What’s your favorite property type currently?

My prior experience taught me to look at a lot of different types of properties, and get comfortable asking questions quickly to get up to speed. I would really encourage LPs to do the same thing.

Should you start with one type? Sure, you can.

Will you end with a single type? Probably not, and diversification is important - across GPs, property types, and I’d also remind you that you can only have so much tied to illiquid investments in general (more on that here).

I think many people think that property types are EXTREMELY different and stick to one (usually that’s multifamily). While operating the asset can be very different for the GP, I think what you’ll find is that - from an LP perspective - analyzing different property types is 70-80% the same. Of course there are intricacies that you’ll ask and pick up on, but the overall framework is the same - so dig in, and don’t be afraid to learn.

So, we now see how these two questions are very related - it might be time to be pencils “neutral” in one property type, while taking the time to learn another.

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If you’d like to speak on the phone, you can reach me at aleksey@centriocapital.com.