In recent years, Real Estate Private Equity (PE) has been an industry focused on capturing value rather than creating it — driven by projected buyer demand rather than genuine consumer needs. As with all investing, it’s important to know where we are in a cycle and playing the game on the field. In the case of real estate — which, unlike other asset classes, tends to be more grounded in the fundamentals of reality (and therefore produce real returns) it’s become increasingly clear that the game has changed. Many will carry on with business as usual (for what it’s worth, we believe this is the very definition of investing insanity) but we could not be more excited about the opportunity we see to focus on scaling the lower-middle market strategy that we’ve been honing for decades. We believe that the lower-middle market, catalyzed by COVID-19, represents a generational opportunity for building real estate businesses focused on value creation, driven by evolving consumer demand.
In the real estate investment landscape, larger capitalization transactions have historically favored domestic and international institutional investors due to scale, visibility, and perceived liquidity. However, the efficiency of these markets has led to overcrowding, driven by factors far beyond real estate fundamentals. Over the past decade, the expansion of the institutional real estate investment sector has exposed the influence of global capital flows on these large transactions, resulting in historically low capitalization rates and returns primarily tied to projected growth. Yet, as capital flows tighten, national tenants downsize, and hybrid work calcifies — returns have diminished, signaling the precariousness of ‘business as usual’ amidst shifting sands.
In contrast, the lower-middle market real estate sector stands out as an asset class of resilience and opportunity amidst this uncertainty. The alpha in this asset class lies in the underlying state of its development and the lack of institutional investment in the ecosystem. To date the lower middle market has been dominated by fragmented ecosystems of local, relatively unsophisticated investing. This makes sense, given that these opportunities (on a one-off basis) are too small for larger firms to pursue. Moreover, the lower-middle market demonstrates greater resilience to beta-risk thanks to reduced exposure to global capital flows, closer alignment with economic fundamentals, and a more traditional tenant/employer base. Put simply, lower-middle market real estate — grounded in real estate fundamentals — presents a unique opportunity for new firms to emerge and develop opportunistic strategies at the right scale for institutional partners to gain exposure to the asset class.
In this essay we’ll explore:
- The mirage of IRR in real estate private equity
- Real estate as a consumer, not capital-driven business
- Why the lower-middle market is the perfect canvas
- Asset convergence as real estate’s iPhone moment
- Showcasing the economic opportunity for platform strategies
- How operators can be empowered as entrepreneurs
Seeing through the IRR mirage
In private equity real estate, the discourse surrounding investment metrics like Internal Rate of Return (IRR) versus equity multiple starts looking (and working) differently against the backdrop of a shifting capital ecosystem. In an era of cheap and abundant capital, the focus was primarily on short-term liquidity and replaceability. However, in a higher interest rate environment that looks like it will be sticking around for a while, the need for investments that deliver a meaningful multiple on equity becomes more pronounced.
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IRR, a metric emblematic of this previous era, measures the annualized rate of return on investment, assuming immediate liquidity and replaceability — akin to trading commodities. It thrives in a world where capital flows freely, and investments have a short lifespan of three to five years, closely tied to market cycles. While it’s not often discussed — the headline IRR number (let’s say 15%) fails to account for the underlying reality that with each sale and purchase, there are inevitable gaps (especially in the current environment) that result in meaningfully lower returns on a blended basis. While this can be overlooked in a low-rate environment, in the face of limited and costlier capital, institutions with a mandate for long-term wealth-building need to look beyond the short-term allure of IRR.
Enter equity multiple—a metric that abstains from the gratification of near-term liquidity and instead focuses on the aggregate return over the lifetime of the investment. The beauty of compound interest has long been a trademark of investors far wiser than us. In a capital ecosystem where capital is no longer cheap and abundant, a 2-3x equity multiple over ten years may yield a high 20s IRR, reflecting the opportunity for long-term value creation over short-term gains. The fundamental shift from headline IRR to equity multiple underpins the transition from trading boxes to building and growing real estate businesses, where returns hinge on creating enduring value over time rather than generating quick returns that prioritize value capture.
Consumer-driven development post-Covid
The impact of COVID-19 accelerated the "great dispersion" away from dense urban cores. As remote work severed historical tethers to major employment hubs, many chose to relocate, no longer constrained by office proximity. Instead they prioritized affordable living costs, preferable climates, quality school systems, and other lifestyle factors.
This dispersion represents a paradigm shift disrupting the real estate industry's traditional economic foundation and development philosophies. Buildings and communities can no longer be unilaterally shaped by cheap capital, volume, and baked-in assumptions around steady occupancy rates or seamless asset turnover. Developers' former reliance on a pipeline of future buyers or renters willing to accept commodity products is no longer tenable.
In the wake of this reshuffling, consumers possess unprecedented optionality in where and how they choose to live, favoring cities and communities that are purposefully designed for modern lifestyles. Municipalities facilitating integrated live+work+play environments blending hospitality-driven development with third spaces for collaboration, retail, amenities, wellness, and thoughtful placemaking will win in attracting new residents.
The pendulum has irreversibly swung. Today's real estate developments must prioritize delivering superior products and experiences that align with the multilayered needs of modern buyers – individuals and businesses alike (increasingly, these also happen to be one-in-the-same). Generic development checking basic roof-over-head boxes is no longer adequate to inspire the attachment and longevity imperative for sustainable communities. Designing for experience – encompassing intangible factors like authenticity, engagement, and resonance with peoples' values – is pivotal for catalyzing thriving ecosystems. Those who internalize this shift in power from buyer to consumer and act accordingly will stand apart as leaders in building the next generation of real estate businesses.
Fostering innovation in the lower-middle market
As capital becomes more constrained and consumers take the lead in driving development, innovation becomes a prerequisite to a thriving real estate business. The lower-middle market offers the perfect setting for this innovation. Here, the dynamics are different: less about sheer scale and more about the precision of opportunity. It's a realm where creative, forward-thinking approaches to development can not only be financed but also have the opportunity to flourish.
This segment's inherent characteristics—its breadth of opportunities, resistance to broad market swings, and alignment with fundamental real estate values—make it an ideal canvas for development. Investors and operators can engage in more personalized projects, experiment with mixed-use developments, and pioneer sustainable building practices with a level of freedom that larger markets simply can't match. These ventures can lead to high-impact outcomes, setting new standards for productivity, sustainability, and community integration.
The lower-middle market also benefits from a closer connection to local economic and social fabrics. This proximity allows investors to tailor their projects more closely to communities' needs, fostering more responsive and responsible developments. This engagement, in turn, spurs greater community support, enhances the long-term viability of projects, and opens up pathways to untapped markets and demographics.
On a fundamental basis, the scale of investment required in the lower-middle market is unique in that it allows for experimentation without the burden of outsized risk. It's an environment where the relative performance of one building (especially as part of a platform strategy) can't cripple an entire portfolio, encouraging a bolder approach to innovation. This freedom to innovate is critical in an era where the foundations of city living—from the rise of remote work to evolving consumer preferences — are in an active state of evolution and convergence.
Platforms and asset convergence | Real Estate’s iPhone moment
The unveiling of the iPhone by Steve Jobs in 2007 was not merely a product launch; it symbolized a seismic shift in how technology could integrate and enhance every aspect of our daily lives. Jobs introduced a device converging the capabilities of a mobile phone, an internet communicator, and a media player into a single, seamless experience – redefining the boundaries of what a phone could be. Just as the iPhone heralded a new era for telecommunications, a similar revolution looms for real estate – promising to transform it from a collection of individual assets into integrated platforms that serve multifaceted consumer needs.
The concept of asset convergence in real estate, much like the multifunctionality of the iPhone, suggests a future where buildings and spaces offer more than their traditional functions. This paradigm shift views real estate as dynamic platforms – environments that not only provide shelter, shopping, logistics, or a workspace but also deliver a comprehensive suite of services and experiences tailored to the lifestyle of modern consumers. Private equity can unlock unprecedented societal impacts by treating real estate as dynamic businesses rather than static assets. This involves reimagining properties as integrated platforms delivering more than a place to reside or work. Instead, they become ecosystems offering services and experiences – aligning closely with the contemporary ethos of convenience, connectivity, and community.
The platform approach in real estate is more than diversifying uses within a single property – instead, creating an interconnected consumer experience. This strategy leverages the strengths of private equity (capital agility, strategic vision, and operational expertise) to foster innovation across the real estate sector. It encourages a holistic view of property development, where the focus extends beyond the physical construction to include value creation through services, technology integration, and community engagement.
Moreover, this shift toward asset convergence and platform-based strategies in real estate can drive efficiency across the board. It optimizes the use of space, reduces redundancies, and creates opportunities for synergies between different property functions. These efficiencies enhance the consumer experience and contribute to sustainability by promoting smarter use of resources and encouraging more thoughtful development patterns.
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There are categories across the lower-middle market that are ripe for innovation and sit at the intersection of multiple asset class convergences.
We’ve highlighted some key examples - art storage, ghost kitchens, single family leisure, charter schools - that we believe showcase the economic opportunity for platform strategies that superserve today's consumers.
Sports/Entertainment Mixed-Use
Sports and entertainment-centric mixed-use developments leverage subsidies and public/private partnerships to create vibrant communities and platforms with strong underlying economics.
Convergence: Residential + Hospitality + Retail + Office + Sports/Entertainment Consumer-Need: There is a strong demand for neighborhoods that have 24/7 activity, vibrancy, and amenities. These “Live, Work, Play” communities also provide safety and security from always having people in public spaces.
Real Estate Opportunity: Stadiums and entertainment venues are heavily subsidized and often include excess land at a low cost-basis as governments view mixed-use developments as public/private partnerships that benefit community development.
Platform Strategy: Master planning these neighborhoods is complex and requires integration. The various buildings act as businesses that can work together and are now more interconnected than ever through advanced technology and infrastructure.
Value Creation: The Sports/Entertainment business continues to see record growth and profitability. The economic activity these businesses generate are consistently attractive to municipalities.
Art Storage
Art storage merges industrial and retail needs, addressing the art world's storage crisis by redeveloping city-fringe industrial and select-service hospitality assets into modern, tech-driven storage facilities.
Convergence: Industrial + Retail
Consumer-Demand: Only 2% of collections are on display and self-storage is at odds with museums and gallery’s need for revenue generating real-estate.
Real Estate Opportunity: Low cost basis of redeveloping existing industrial and select service hospitality assets on city fringes and neighboring suburbs - great access and egress, above floodplains with pre-existing utilities infrastructure.
Platform Strategy: Due to constraints of asset concentration (~40-100K sq/ft) and the need for proximity to key collector centers this creates a need for multiple ‘connected’ locations.
Value Creation: High-value art requires specialized storage, which commands premium rental rates. The continuous production, acquisition, and movement of art ensures steady demand, and a durable long-term revenue stream.
Ghost Kitchens
Ghost kitchens capitalize on the booming demand for quick delivery of diverse cuisines, transforming underused industrial spaces into efficient commissary kitchens and logistics hubs.
Convergence: Retail + Hospitality + Industrial
Consumer-Demand: The rise of online food delivery services and changing consumer preferences towards convenience dining drives the demand for ghost kitchens.
Real Estate Opportunity: Utilizing obsolete industrial spaces or developing modular units offers a low-cost basis and flexibility in operations. These kitchens can quickly adapt to trends in cuisine and changes in consumer demand.
Platform Strategy: Specialized coverage of key geographic regions for delivery combined with bulk purchasing power within a regional platform.
Value Creation: Ghost kitchens operate with significantly lower overhead than traditional restaurants and are the right production model to pair with the proven and growing demand for online food delivery. They can rapidly scale in high-demand areas, while maintaining flexibility to respond to the growth of new communities.
Single Family Leisure
Single-family leisure takes the most desirable aspects of hospitality and second home ownership to deliver a best-of-both worlds experience in a category with proven resilience across economic cycles.
Convergence: Residential + Hospitality
Consumer-Demand: Higher interest rates and carrying costs have made traditional vacation home ownership less attractive, increasing the demand for rental vacation properties with the built-in amenities of hospitality.
Real Estate Opportunity: Purchasing distressed properties from developers at a discount provides a low cost basis and the potential for high-value transformations into desirable rental properties.
Platform Strategy: Variety of locations and destination types combined with the efficiency of operations across multiple homes enables the capture of broader ‘vacation share’ while consistently delivering a high-quality experience.
Value Creation: Vacation rentals generally offer higher yields than long-term rentals due to premium pricing during peak seasons. Additionally, diversified locations and property types can attract a broader customer base, increasing occupancy rates and maximizing year-round returns.
Charter Schools
Charter schools address critical gaps in early education, particularly in rapidly growing regions. By converting obsolete retail spaces into educational facilities the pressing needs of growing communities can be met while fostering educational consistency and quality through integrated management systems.
Convergence: Retail + Educational Services
Consumer-Demand: There is a growing need for educational facilities in rapidly expanding suburban and urban areas, particularly where traditional school infrastructure cannot keep pace with population growth.
Real Estate Opportunity: Redeveloping underused retail spaces into schools leverages existing buildings at a reduced cost, often in locations already well-suited for community-based facilities.
Platform Strategy: Operating multiple schools in an area to form a ‘school district’ allows families that move houses to stay in the same educational program while ensuring consistent programming and operations among the schools.
Value Creation: Educational facilities typically secure long-term leases, providing stable cash flows. The demand-driven nature of education, coupled with government and community support, can lead to sustainable revenue. Additionally, operating multiple schools under a management company can achieve economies of scale, lowering operational costs and increasing margins.
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Overall, the strategic interlinkage of these platforms under the umbrella of lower middle market real estate investment showcases a model of adaptive reuse that is both economically viable and crucial for meeting the changing needs and preferences of today's society. By viewing real estate through this lens of asset convergence, private equity can lead the charge in creating ecosystems that are not just physically innovative but also enable vibrant hubs of human activity, productivity, and connection.
Elevating operators from executors to entrepreneurs
Empowering operating partners in real estate transcends the mere provision of capital; it requires a deep commitment to nurturing the expertise these individuals bring to transform visions into tangible, valuable assets. These operators are not just project executors; they are visionaries and community builders, and as such, they deserve a partnership that enhances their capabilities and ensures the sustainability of their businesses.
There are three key elements to an integrated relationship between a private equity firm and an operating firm, which accelerates the time to create value and takes advantage of the unique dynamics of the lower middle market.
Strategic Finance
Strategic finance is more than equipping operators with financial tools – it's integrating investors and operators in a partnership that shapes the overall business model. Viewing each building as a business within the larger platform means that all macro and micro inputs must be meticulously integrated. Platform investing necessitates a more rigorous underwriting process for the individual real estate opportunities and the operating partners themselves. This collaborative approach between general and operating partners enhances the distribution of risk and improves portfolio management. By sharing multiple perspectives and skill sets, the partnership ensures that financial stability is maintained and enhanced by multiple transactions and significant capital commitments to the operators' firms – offsetting the incremental burden of increased diligence and controls.
Partnership Development
Partnership development takes on a crucial role, focusing on forming relationships and identifying anchor tenants to create a thriving consumer ecosystem. These tenants include branded operators of new retail and professional services with physical storefronts (e.g.,primary care facilities, dental offices, and veterinary clinics) and industrial co-manufacturers, commissary kitchens, and charter school systems. These partnerships are pivotal, as they fulfill immediate commercial needs and draw in further business, creating an environment where each tenant contributes to and benefits from the ecosystem's overall health.
Community and Municipal Engagement
Community and municipal engagement involves a strategic understanding of the past, present, and future urban and community planning to ensure that real estate projects endure and bring the community's vision forward. Effective engagement means operators must work closely with city planners, local governments, and community groups to align their projects with broader civic goals — ensuring that developments are welcomed and integrated into the fabric of the community. This alignment enhances the projects' viability and sustainability — making them critical contributors to the community's long-term growth and success.
By focusing on these sophisticated elements of investment (strategic finance, partnership development, and community engagement) the role of investors evolves from funders to true partners. This approach not only empowers operators to excel but also ensures they are building sustainable, thriving businesses that align with the needs and aspirations of all stakeholders. This strategic partnership fosters a generation of real estate enterprises that are robust, innovative, and integral to capitalize on the opportunity that will shape the lower middle market for decades to come.
Real estate’s role in the new economic order
The lower-middle market in real estate private equity presents a profound opportunity to redefine the essence of value creation within the real estate sector. This segment offers the unique ability to construct properties and forge vibrant, productive communities. By concentrating on platforms that closely align with cities' economic and social fabrics, investors can transcend the traditional model of trading boxes for a more meaningful approach that emphasizes enduring value.
The upheavals brought by COVID-19 have accelerated these trends. The shift toward remote work has decreased foot traffic and diminished public transit use, impacting local businesses and tax revenues. Employers questioning the necessity of expansive office spaces have contributed to the growing vulnerability in commercial real estate.
These shifts are not merely transient adjustments but signal the emergence of a new economic order. We are witnessing the confluence of multiple mega-forces—from the impacts of geopolitical upheaval driving U.S. defense production to the industrial reinvigoration driven by the CHIPS Act. Additionally, the pandemic has underscored the critical need for reshoring and the renewal of domestic manufacturing, a movement further amplified by the climate crisis and commitments to decarbonize the economy. This new economic landscape is supported by unprecedented federal spending and policies rooted in modern supply-side economics, collectively forging new industrial geography across the U.S. These macro dynamics and public investments are altering the physical infrastructure and creating fertile ground for the next wave of economic development.
As we prepare to delve deeper into these themes in the future, focusing on how these disruptive catalysts continue to shape the investment landscape, it is clear that the lower-middle market in real estate private equity will be at the forefront of these transformations. This segment offers a strategic vantage point from which to participate and collectively benefit from the ongoing reconfiguration of urban and economic frameworks. By investing in this sector, stakeholders contribute to and capitalize on creating resilient, forward-thinking cities whose communities will inevitably play a crucial role in the new economic order.
This moment in history presents a call to action for investors: to embrace and drive the development that will define the cities of tomorrow and ensure that real estate remains relevant and robust amidst the changing contours of our society and the economy.
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