Advancements in technology have long helped financial services firms boost analytical capabilities, gain insights into market activity and seize new investment opportunities. Private equity firms, however, have been slower to respond to tech trends, especially when compared to their hedge fund or venture capital peers, relying in many cases on outdated infrastructure.
But PE has been profoundly shaped by innovations in recent years, with real estate funds in particular benefiting from the advent of automated tools and fully digitalized products to help expedite operations and customize investor services. More managers have taken steps to embrace biometrics and paperless reporting, or install highly advanced cybersecurity protections and encryption to protect data and fully secure networks. Virtual assistance helps investors navigate daunting PE forms, and drones assess the entire landscape of properties to help inform investment decisions. But, it has been algorithms that have recently assumed a critical role in PE real estate, helping to identify commercial properties for potential deals.
PE firms can use algorithms to quickly gather and analyze large volumes of data to dramatically improve the deal-vetting process for investors. They can narrow the pool of potential investment properties, filtering out poor candidates based on size, location, geography and other factors. They can also save firms from relying on a small force of analysts to hunt for the best deals in a more manual, labor-intensive process.
Such algorithms are particularly critical for PE firms that target smaller markets. Plum real estate deals in prime markets like New York or San Francisco could eventually lead to lucrative payouts for the bigger firms that pursue them — but deep pockets can also be an impediment. Large PE and hedge fund players focusing solely on generating fees get stuck, trapped in multibillion-dollar deals with no return. As a fund grows and scales, big deals typically have much lower returns.
The competitive landscape can be intense for bigger firms, often limited to targeting properties larger than $25 million. That essentially locks them out of smaller markets where deals are worth less, but are much more abundant.
But the PE firm that can skillfully descend on overlooked markets in Wisconsin, Iowa or Mississippi, such as with self-storage units, identifying opportunities in a fragmented sector, can potentially reap rewards. Smaller firms can compete in the “volume game” in ways large firms can’t. These overlooked markets can be strategic targets when the supply is there, but the demand is not. Going after many small deals and hunting for micro changes that will compound in astronomical ways, however, requires considerable time, diligence and patience.
Data points can help deals bubble to the top so firms don’t have to review each property. They require a skilled and disciplined manager with a methodical approach. While technological tools can help collect predictive data, grow economies of scale and lower operational costs, they don’t change a firm’s culture alone. For that, they need someone who recognizes the power of relationships with people and not just transactions.