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Down round

Why some real estate funds will be allowing LPs to downsize commitments.

You know the real estate market is in trouble when it starts to resemble the venture capital market of 2002.

Among the post-bust VC symptoms now affecting private equity real estate is the phenomenon of the right-sized fund. Back in the early part of this decade, venture capital firms gamely slashed their fund sizes after having raised vehicles of unprecedented dimensions.

Today, we have evidence that the same trend may have begun in real estate.

News broke this week that New York-based property investment giant Westbrook Partners informed its limited partners that they would be able to cut their commitments to the most recent $2.5 billion fund by 10 percent or more.

It is unlikely that Westbrook will be the only firm to make this offer. That said, the magnitude of this round of downsizing, and the reasons for it, are far different than for the venture capital market of 2002.

Back when the world was still suffering from dotcom hangover, it became clear that the billion-dollar funds of Silicon Valley were instant anachronisms – pools of investment capital formed for historically overpriced business plans.

What's more, the institutional investors that backed these funds came to the conclusion that they, in fact, despised the venture capital asset class (was it the Pets.com sock puppet that put them over the edge?)

Today, by contrast, institutional investors continue to believe in real estate as an asset class, but the general meltdown across all markets has meant a liquidity crunch that is preventing some from sending the agreed-upon level of capital towards property investment (and private equity, and infrastructure, and everything else).

Sadly, many LPs are aware that if ever there was a time to double down on real estate, it is now.

Westbrook's LPs no doubt wish they didn't have to downsize, but they truly worry that they may not have the cash to meet the next several years of capital calls. Better to restructure the fund to match the reality of the LP base than to stubbornly carry on as if the world had not been entirely rearranged.