In the second of our 2020 outlook Q&As, Gene DelFavero, chief financial officer of Boston-based Alcion Ventures, speaks to Private Funds CFO about the outlook for consolidation in the real estate PE world, why he thinks it’s time be a seller, and what Alcion is doing to prepare for the year ahead.
What have you set your sights on for 2020?
In 2020, one of our big carry overs from 2019 has been the use of technology and how it can increase efficiencies and mitigate costs, and that has included transitioning all our in-house IT and phone systems to a public and private cloud-based system. In addition to that, we’re constantly looking at outsourcing to see if outsourcing makes sense, but as of yet, it hasn’t. We are also continuing discussions with various service providers to see if there are any systems that will help us automate some of our investor reporting and asset management. From an operational standpoint, I’m continuing to ensure that our business plan is in line where our assets are, where capital markets are at, where the economy is, and what adjustments should be made in the case of a downturn.
What parts of your back-office function are automated? And what do you hope to automate in 2020?
I’m always looking at solutions with my team. We really just started touching upon AI. We’re an opportunistic fund that uses operating partners that we invest with, and are not vertically integrated, therefore, making it a little harder to use AI from a cost perspective.
At the fund level, there is not a large amount of repetitive work – such as accounts payable or bank reconciliations – that would lend itself to the cost-benefit of using AI. However, we will continue to look at AI to see if it can help with some of the repetitive investor reporting by minimizing the time required to gather data from our operating partners, and also look at how we can compile the data so we can utilize it in our asset management and internal reporting. We’ve looked at various solutions on and off for a while, and I think we’re going to be making more of a push to look at some of those systems this year.
How are you grappling with the record levels of dry powder at the beginning of this year?
There are a lot of investors out there that I’ve seen – at least from the real estate investment fund world – that are going to the bigger funds. There are a lot of investors that feel we are late in the real estate cycle and are being more cautious now because multiples are high. As LPs migrate to bigger funds, I think that is going to lead to a consolidation of a lot of managers. We’re beginning to see it already. Different vehicles trying to vertically integrate themselves and adding on real estate arms. Also, I think you’re going to see more horizontal mergers where you just get two PE real estate shops getting together because they share the same investors and I think investors are going to start asking, “Who are the managers we’re going to keep?” Even though there’s a lot of dry powder, you’re not seeing a lot of new investors come back into play and saying we’re going to make commitments to the smaller or mid-size funds.
From an asset side, the valuations asset pricing has plateaued unless you can underwrite significant growth, for example, like the market in Raleigh, North Carolina, where there are a number of drivers of demand causing consistent rent growth. In the markets where you can underwrite growth you will continue to see cap rates decreasing and values increasing. You’re seeing core funds chasing alpha by doing more opportunistic deals. With the amount of dry powder out there, it’s a prime time to be selling assets. I think it’s going to be a harder time buying because you have various classes of investors crossing sectors, i.e. core to non-core, and chasing the same investments thereby pushing cap rates down and driving valuations. At times it feels like investors are rationalizing prices or risk. You need to be a sharpshooter and stick to your principles in today’s market.
What are you most worried about in 2020?
It’s really looking at strategies on our existing assets while interest rates are low, the economy is still pushing along, and things are going great. It just begs the questions: are we ready for when downturn happens? Where are we with our assets? Have we taken the assets that we have executed our business plan on to market, rather than chasing the last dollar of profit? Have we taken the appropriate actions on our investments as to allow us to maximize value and ride out a disruption in the market? For 2020, it’s just about preparing ourselves for the future. I think there will be some sort of a disruption – I don’t think it’ll be a major disruption but we’re focused on locking down what we think could affect us. From the back-office or regulatory side, its knowing that we have plans and procedures in place. It is also trying to get ahead of where we see the next risk and to make sure we are prepared for it. An example of that was our transitioning to the cloud since we were able to add additional layers of cyberprotection that would have been more costly if we had maintained our systems in house.