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Innovative investment funds dedicated to ground-up urban development can deliver superior returns. They can also be pivotal in enabling sound urban development and the sustainable use of urban infrastructure.

Investment funds dedicated to ground-up urban real estate development are a relatively recent asset class that is experiencing significant growth and internationalisation. Aiming to generate attractive risk-adjusted returns for its investors, these funds use innovative structures of investment and development to intermediate between global capital sources and local urban development projects.

Fund managers seek to identify scarcity of capital and pricing dislocations based on where markets are in the cycle to define an investment strategy that supports raising capital from institutional investors, which can be located across the globe. Once a fund is raised, the capital is then deployed with a predefined mandate in multiple deals in specific asset types and urban markets typically alongside local development partners.

This set-up enables investors to have access to deal flow, asset management capabilities and specialist oversight in a target sub-sector of the real estate market without having to build proprietary investment platforms. In turn, local developers and operators are provided with stable long-term sources of equity capital, credit enhancement, operational expertise and an additional fiduciary overlay.

For cities, the new investment funds are becoming increasingly important as enablers of development projects that support the sustainable use of urban infrastructure and create opportunities for place making. With a unique over-arching view of development activity, they can influence how cities grow through the projects that they choose to invest in.


Investment structures

Funds are typically managed, advised and co-invested by a specialist fund manager with pre-agreed investment objectives. Investors own stakes in each deal through their investment in the fund, with most investment objectives delegated to the fund manager. The lifespan of the fund is usually split between an investment period and a harvest period, when capital and profits are returned back to investors.

To ensure alignment of interests, a sponsor will typically seed the fund with assets and co-invest a material amount. Fund compensation usually includes a management fee plus a bonus structure in case of out-performing pre-agreed benchmarks.

Deals are typically structured as joint venture partnerships with local development partners who are responsible for implementing the business plan. Each party is required to contribute equity capital to the project and there is often as well a tiered compensation structure tied to each party’s equity participation and performance.

Deals presented by local development partners are selected based on predefined investment criteria which typically entail asset type, geography and target risk-adjusted returns based on specific capitalisation structures. Extensive analysis is required to determine whether market fundamentals support the underwriting assumptions. Local partners should have a proven track record and experience in the local market and demonstrate that they have the resources and balance sheet required to execute the business plan.


Generating returns

Fund managers seeking to generate superior returns in urban development must be able to identify market dislocations and capitalise on illiquidity based on where markets are in the cycle. A sound investment strategy should be based on a comprehensive process to originate, evaluate, structure and execute each of the fund’s investments.

Extensive proprietary market and asset-level research is required to determine those sub-markets most conducive to producing compelling returns. The ability to establish a proprietary sourcing platform is often a key determinant for accessing deals at an attractive land basis.

Funds should closely monitor and manage the performance of each of its investments, implement asset-enhancement business strategies and continuously evaluate opportunities for potential strategic or exit opportunities.

Ground-up development is a specific asset class that requires specialised knowledge and an investment platform with a multidisciplinary development expertise required to source, design, build and finance the fund’s projects.

Each investment opportunity requires extensive design development and costing to be fully underwritten based on an understanding of risks and availability of financing. A collaborative approach early on can help maximize value and reduce delivery risk so that the land basis can be accurately valued based on return estimates at the project and partner levels.

Having local partners and investing with multiple operators specialised in different asset types over several years through different phases of economic cycles provides for enhanced risk mitigation. Local relationships take time to develop and require adding value beyond capital allocation.

Local operators tend to favour investment partners with flexible investment strategies who have the experience of both local markets and ability to provide investment capital, credit enhancement and development expertise able to add value through tangible property-level measures.


Shaping urban development

Investment funds dedicated to ground-up urban development are an innovative asset class that can deliver superior risk adjusted returns to institutional investors. Successful investment platforms provide strong alignment of interests with its investors and have a sound investment strategy based on extensive research to identify pricing dislocations based on where markets are in the cycle. An investment platform with multidisciplinary expertise able to add value throughout the development process is a key differentiating factor for investors and local partners.

Furthermore, fund managers have a unique over-arching view of the development activity in different sub-markets. Using planning criteria in the investment process as well, such partnerships have a transformative ability to deliver returns to investors and also influence how cities grow — playing a pivotal role in enabling sound urban development  and sustainable use of urban infrastructure.