A Framework for Evaluating Alternative Investments
Parker Webb
There are a lot of ways to lose money in alternative investments. Most of them aren't from the investment itself going bad — they're from investing without a coherent framework for evaluating what you're buying in the first place.
After years in private real estate and watching the broader alternatives space closely, here's the framework I come back to for every opportunity.
1. What is the return driver?
Every investment has a primary engine of return. In public equities, it's earnings growth and multiple expansion. In bonds, it's yield plus or minus price movement from rate changes. In private real estate, it's some combination of cash flow yield, forced appreciation through operational improvement, and market appreciation over time.
Understanding the return driver isn't just academic. It tells you what to underwrite. It tells you what could go wrong. And it tells you whether the projected returns are realistic given the assumptions about that driver.
A fund projecting 20% IRR from a yield-focused strategy in a low-cap-rate environment should raise questions. A development deal projecting returns entirely from appreciation with no cash flow should raise different ones. And vice versa.
2. What are you actually paying for?
All alternatives have a cost structure. Management fees, acquisition fees, disposition fees, promoted interest (carry). The headline return number should always be evaluated net of all fees. A 15% gross IRR with a 2% management fee, 1% acquisition fee, and 30% promote looks quite different net than it does gross.
Ask for the net return projections. Any reputable sponsor provides them.
3. Who is operating this?
In private markets, operator quality is not a secondary consideration — it's often the primary variable. Two operators can buy the same asset in the same market with the same debt and produce wildly different outcomes based on their underwriting discipline, operational competence, and capital markets sophistication.
Track record matters, but it's not sufficient on its own. Understanding how the operator thinks, what they've learned from deals that didn't go as planned, and how they communicate with investors when things get hard is equally important. You're not just buying an asset. You're entering a relationship.
4. What is the structure?
Preferred return, equity split, waterfall, redemption rights, co-investment opportunities, reporting cadence — the structure of the deal determines how returns flow and how aligned the operator's incentives are with your own. A structure with a meaningful preferred return and a reasonable promote aligns the operator to produce cash flow before taking profit. A structure heavy on acquisition fees and light on promote does the opposite.
5. What does the exit look like?
Every private investment has a planned exit, whether it's a sale, a refinance, a fund wind-down, or a public offering. The exit assumption is often where projections get heroic. What cap rate are they assuming at exit? What does the market need to do for that to be achievable? What happens if the exit timeline extends by 2 years?
Stress-testing the exit is one of the most important parts of due diligence, and one of the most frequently skipped.
The meta-point
This framework won't make you immune to bad investments. But it might reduce the probability of investing in something you didn't fully understand. In alternatives, as in most things, one of the best protections against loss is asking the hard questions before you commit.
