Don’t be sheep

A couple of key themes emerged at the recent PERE Forum in New York. Chief among them was a warning to those who just follow the herd.

Growing up, one of the bargaining techniques we used to try to convince our parents to allow us to do something was to tell them that all the other kids also were doing it. If your parents were like mine, however, their response often went along the lines of just because your friends are doing something doesn’t mean you need to do it too. For added effect, my mother would add, “If they jump off a bridge, are you going to jump too?”

You couldn’t help but be reminded of that analogy listening to the speakers and panelists during the second day of the PERE Forum in New York this week.

With boatloads of capital chasing core properties in select US markets, the herd mentality among investors and LPs couldn’t be more obvious. Poor performance over the past two years has led to a flight from perceived risk, and now everyone and their brother are bidding up core assets – a trend that is only likely to accelerate next year.

Therefore, limited partners were urged not to blindly follow the surge of capital chasing core real estate assets, as the increased competition and resulting lower cap rates have made these ‘safe’ assets as risky as value-added or even opportunistic strategies. This is particularly true given the lack of economic drivers behind the growth assumptions used by fund managers to underwrite many of these deals.

Still, like many of us in our youth, don’t expect many limited partners to heed this cautionary note, as most LPs are too passive to force their fund managers to change. Those conclusions led one speaker to say: “If you act like sheep, expect to be fleeced”.

That sentiment was echoed by Mark Burton, a member of the real estate advisory board of Norges Bank Investment Management, which manages the capital of Norway’s $300 billion sovereign wealth fund. He added that limited partners need to speak out more on advisory committees if the real estate fund model is to work in the future.

Indeed, several speakers, including Burton, believe the fund model already has lost its appeal for some. Thomas Barrack, chairman and chief executive officer of Colony Capital, told the audience that co-investment vehicles will be the investment model of choice for larger investors in the near future as they shun capital allocators and increasingly move towards direct deals.

Barrack went on to warn that all LPs “wanted more for less” and – like the wider economy – wanted to be “consumer direct”. As a result, “if you are only a middle man [capital allocator], you are going to be in trouble,” he said. Those allocators, however, may be spared the brunt of this revolt as only some of the largest institutional investors have the size and capabilities to invest directly or through co-investment vehicles today.

For those that do end up going direct, perhaps the following adage is apt: we never know the love of a parent until we become parents ourselves.