The Hedge Fund Real Estate Market: An Insider's View

During part 5 of our 6-part Hedge Fund Launch Webinar Series, we discussed the real estate frontier for startups with guest Ben Friedland, Executive Vice President at CBRE in New York, and his colleagues.
               
When searching for a space for your firm, “The trickiest part is the great unknown,” said Friedland, expressing perhaps the most common sentiment of new managers. “Flexibility,” he continued, “is the most important factor.” As a new manager, you must be willing to ask yourself, How is my firm going to do? Will it double in size in a year or shut down?

This uncertainty calls for careful consideration of what type of space is best suited for your firm. Friedland described four typical types of spaces:

• Direct spaces;

• Sublease spaces;

• Temporary office suites; and

• Shared spaces

Each type of space has its pros and cons, he explained. Temporary office suites, for example, provide the greatest flexibility for firms still determining their budgets, headcounts, etc. However, they lack dedicated area confidentiality. Similarly, confidentiality issues may arise from shared space, or desk share arrangements, unless a firm has the right synergy with the host firm. Direct spaces offer tenants a direct relationship with the landlord, yet tend to be costly. Finally, sublease spaces offer “plug and play”, which is a term used to describe spaces that are complete with furniture, wiring and infrastructure from day one.

Friedland noted, “Naturally, this is the most appealing arrangement for new firms. During fund formation time, there is so much going on. Groups want to minimize the amount of effort and time spent on real estate.” However, new managers often overlook the fact that the sublease availability rate is extremely limited – just under 2% of all available spaces. In addition, there are risks associated with this type of arrangement, specifically, the lack of a direct legal contract with the landlord. “If you sublease space from a group, and that group goes out of business, you as a tenant would be out on the street,” warned Friedland. For a proactive approach, he suggested working with a broker that carefully evaluates sub landlord risks.

Given the variety of different spaces available, the timeline for new firms to be up and running can vary considerably. According to CBRE, the typical process spans across three timeframes as outlined below:

• Fast track: 11 weeks

• Typical build: 22 weeks

• Full build: 30 weeks

In describing the full build timeline, Friedland laughed, “The appetite for new hedge funds to spend time, human capital and money to build a new space is usually zero.” Naturally, it is the “plug and play” subleased spaces that are the most in demand. Still, there are factors that may influence even the fast track timeline, such as, bringing in an attorney to negotiate the lease and allowing a landlord 30 days to approve or disapprove of a prospective tenant.

Friedland noted that geographic boundaries have shifted considerably in recent years. “All of the hedge funds wanted to be on Park [Avenue], Fifth [Avenue] and Madison [Avenue] between 42nd Street and 60th Street,” he said. Friedland continued, “When firms came to town to allocate money, you were right in that path.” Now, location depends on two things: where the principal of the firm lives and how confident a firm is in its fundraising abilities. According to Friedland, a prominent fund might say,  “I want a cool space in the Flat Iron District.” However, although what is considered an acceptable location is changing, there remains a standard for the quality of the building. Firms typically gravitate toward areas where there is new construction. Friedland makes the distinction between quality and opulence, noting that many firms avoid spaces that project spending investors’ money in a frivolous way. Other common requests are buildings with a floor plan proportionate to the size of a respective firm as well as built-in amenities.

Many new managers ask about a typical security deposit. “When a firm is just starting out, it has no assets,” explained Friedland. “So we try to paint the new fund in the best light possible, including bios on the founders, where they came from, their track record and history. Anything that makes the new group look as stable as possible.” Friedland explained the benefits of a “good guy guarantee”, which is a provision to prevent squatting. In short, it is an arrangement in which a landlord, for a certain period of time, is permitted to go after a tenant that has defaulted on their lease and refuses to vacate. Friedland feels that oftentimes it makes sense for tenants to take 6 months and a “good guy guarantee” rather than a 12 month deposit.  In the big picture for new funds, Friedland believes managers should anticipate spending a 9-to-12 month security deposit.

For emerging managers beginning the real estate process, Friedland cautions, “You get out what you put in.” He suggested working with one group that perhaps was referred by a friend who you know you can trust. That one broker will “quarterback everything” and be on your side, walking you through the pros and cons of available spaces. Friedland reminds new managers to remain open-minded, conduct a comprehensive search and ensure they have at least one back-up option when it comes to real estate.