For a small check, is a conversion fund with ten buildings safer than one building you can go inspect

Question

For adaptive reuse, the choice between a fund and a single asset comes down to two different kinds of risk, and a small check may not belong in either. A fund raising a large amount to buy obsolete office and convert across eight to twelve buildings, mostly blind at the time of commitment, offers real diversification. Conversions fail building by building, since floor plate, window line and riser capacity each carry their own risk, and a fund lets one bad building be a bad building instead of the whole outcome. A sponsor who has run the playbook repeatedly has usually seen more of the failure modes than a first-time single-asset investor. A single named building offers the opposite advantage: the ability to read the actual feasibility report and the actual budget for the actual structure, rather than buying a process that can't be inspected while paying fees on committed capital during a search period. If the strategy depends on most buildings not penciling, a fund still has to find enough that do, and the pressure to deploy capital on a timeline is real. There's a legitimate third position too, which is that a small check has no business in either structure until it's grown enough to absorb a bad outcome in either direction. The diversification argument and the inspect-it-yourself argument both hold up on their own terms, and the right answer depends heavily on check size relative to total portfolio.

megan_doyle15 · Answer

Brand new here so I might be missing something obvious, but if most office buildings don't convert well, doesn't a fund buying ten of them just guarantee you own some of the bad ones?

tylerbrooks9 · Answer

@megan_doyle15 that's the counterargument in one line and it isn't naive. A fund averages outcomes. Averaging helps when individual outcomes are random and hurts when individual outcomes are selectable. Whether conversion feasibility is selectable is the actual question in this thread. The third option holds up best here. If a building can't be judged on its own merits, getting paid for judging it doesn't make sense, and in a fund the real underwriting is one team's judgment for six years, which is harder to check than a floor plate.

carlos_nunez · Answer

Feasibility is absolutely selectable, and that is the whole argument for the fund. Teams doing this at volume look at forty buildings and buy three. A single-asset buyer wants the one building in front of them to work, because they found it and already spent money on it, and that attachment tends to weaken discipline compared to a stranger evaluating a pipeline with no emotional stake in any one deal. @brandonlee36, the fund fee drag is real though. Fees on committed capital during a two year acquisition period is a genuine cost and it comes straight out of the number.

mitchell_ray4 · Answer

Trades side view. The thing that kills these is what's inside the walls, and you can't see that from the lobby. So the "go stand in the building" advantage is smaller than it sounds unless you're paying for probes, cores, and a full mechanical assessment. Which the fund is doing on every building and you probably are not on your one.

The flip side is the fund did all that and you never get to read it.

tashaford30 · Answer

The single asset lets an investor read the report. Does anyone actually get the full report, or is it always a summary memo? Because if it's a memo either way, the fund structure loses most of its advantage.

tonyv88 · Answer

@tashaford30 in practice you get the full report if you ask early and you're a large enough check, and a memo if you're small or late. So for a small check the difference between door one and door two can collapse to nothing on the information side. Management angle nobody's raised: a converted office building is an operating asset with weird bones. Odd unit layouts, interior units with borrowed light, one elevator bank sized for 9am office traffic. Lease up on those runs differently than a new build and the pro forma rent per foot often assumes it doesn't. A fund with ten buildings has ten of those problems and a team that has seen them. That's the case for the fund.

ryanmck27 · Answer

Voted fund. My reasoning is unglamorous, I'd rather diligence one team once than one building repeatedly.

diane_kowalski · Answer

I'd separate two things that keep getting mixed here. Diversification of building risk and diversification of sponsor risk are different, and a fund only gives you the first. Ten buildings, one team, one set of judgment errors, one guaranty behind everything. If the team's cost assumptions are systematically light, all ten buildings are light in the same direction and the diversification does nothing for you.

Ten single-asset deals with ten different sponsors would give you both, and almost nobody has the check size or the time to do that. Which is maybe why @tylerbrooks9's third option keeps looking reasonable.

aaron_fitz10 · Answer

@diane_kowalski's point is the one that lands hardest. Correlated errors across a portfolio is exactly what conversions would produce, because everyone is using the same cost data and the same optimism about permit timelines. Still, the fund case holds up for a small check, because the realistic alternative usually is not ten sponsors, it is one building most buyers do not understand well enough to underwrite alone.

jordan_ellis2 · Answer

I've been reading for six months and have closed nothing, so take my vote as a vote and not as a view. I went with the third option. What decided it was @brandonlee36's own sentence about pressure to deploy. A fund that raised $200m has to spend it, and a strategy that depends on saying no to most buildings sits badly with a fund that has to say yes to enough of them. I'd rather watch a couple of these funds report actual conversion costs against their original budgets for another year or two before I have an opinion worth acting on.

For a small check, is a conversion fund with ten buildings safer than one building you can go inspect

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