Diversified private real estate investment funds limit how much of a portfolio to devote to any single asset, no matter how attractive its prospects. However, some investors can increase their returns when they come along for the ride in a sidecar.
Fund managers offer sidecar investments when they find a great asset that costs more than the fund’s property allocation. Instead of taking a pass on a good deal, they bring in individuals as co-investors. The fund manager does the vetting to acquire a property, then asks if investors want to participate directly alongside the fund’s investment. Unlike syndications, which are co-investments between a sponsor and a group of investors, sidecars are driven by the fund’s interest in the asset.
For example, a property may be awarded at $25 million, but the fund’s maximum allocation for a single property may be $15 million. To complete the deal, the fund uses $15 million of its existing capital commitments and creates a sidecar vehicle for investors in the fund to provide the remaining $10 million in equity.
Investors make sidecar investments for the same reason as the fund manager—to take advantage of a good opportunity for a profitable investment. The arrangement is not new but is newly pervasive, as private equity real estate funds and their high-net-worth investors find common cause in expanding their portfolios.
Asset managers can use sidecar investment vehicles to secure capital commitments quickly, which can be essential in negotiations. This lets them complete the transaction without giving one single property undue weight in the fund’s portfolio, lowering its idiosyncratic risk. And they can structure the deal with less reliance on loans, decreasing its leverage risk.
When private real estate funds offer sidecar investments, investors are contacted individually and offered the chance to co-invest, with the opportunity to say yes or no to chip in additional equity. Sidecar commitments are typically allocated among interested investors on a first come, first-served basis, or according to their proportional investment in the fund, so that the opportunity is transparent and fair.
A sidecar’s fuel is the investor’s relationship with a trusted co-investor. Investors get the judgment and skill of an already-vetted asset manager who shares their investment philosophy and business interests. The attraction for many sidecar investors is the fact that they can benefit from the intense underwriting and due diligence the asset managers put into evaluating the deal. The opportunity comes to the investor without the investor needing to do any extra research and the fund sponsor bears most of the legal and accounting costs of closing the deal. Past experience will have confirmed that the investor and fund manager are already aligned on investment strategy, with the added benefit of getting the right of first refusal on properties from a source that has proven trustworthy in previous dealings.
Harvard economist Richard Zeckhauser, who popularized the sidecar idea, saw sidecars as a way to benefit from the special skill some people have at sourcing investments—like the early Berkshire Hathaway stockholders who invested alongside Warren Buffett. Zeckhauser used the motorcycle sidecar rider as a metaphor. Above all, the investor must be confident in the driver.
How Sidecars Work at Origin Investments
Origin offers sidecars on a select number of acquisitions a year for strong deals for their Qualified Opportunity Zone and IncomePlus Fund, when asset allocations cannot cover the entire amount of the purchase.
There are inherent conflicts with sidecar arrangements if the fund manager offers different terms to co-investors or brings in individuals who do not participate in the underlying fund. For that reason, Origin offers sidecar investments on a first come, first-served basis to current Origin Fund investors and they sell out quickly. Asset managers who bring in outsiders as co-investors may not be operating in fund investors’ bests interests.
All told, opportunities for co-investment in sidecars can further drive investors’ interest in participating in a private real estate fund, allowing them to sit back and enjoy the ride.