Friday Letter Beating the clock

Fund managers are running out of time to deploy existing capital, but the pressure to invest could drive more activity among opportunistic players. 

These are worrying times for global real estate investment, as increasing economic uncertainties have resulted in a painful backlash from nail-biting real estate investors. Indeed, for the first time in three years, the amount of available real estate capital for investment is shrinking, not growing.

New capital available for investment in 2012 has slipped 4 percent to $316 billion from $329 billion at the end of 2010, according to “The Great Wall of Money” report released by real estate services firm DTZ. At the same time, new capital raising has continued to decline and is now less than one-third of the level that it was at the end of 2009, when the company first began tracking new capital targeting direct real estate.

Furthermore, the level of available capital is expected to drop even more, as managers are under the gun to deploy capital in funds raised in 2007 and 2008 and are now nearing the end of their investment periods. With time running out for capital to be called, the need to move quickly could spur more opportunistic real estate investment activity.

According to Hans Vrensen, global head of research at DTZ, the reason so much existing capital in opportunity funds has yet to be deployed is the lack of suitable opportunities. While there have been opportunities to invest in core markets, those types of investments don’t fit the higher risk/return profile that opportunity funds are seeking – usually in the 15 percent to 20 percent return range.

With the clock ticking on capital deployment, fund managers have several options if they want to avoid returning capital commitments to investors. One is asking their investors for an extension – generally between one and two years – of their commitment periods. Vrensen expects extensions will be granted in about half of the cases. Because of unprecedented conditions, both in the real estate and financial markets, “there might be more understanding from investors compared to a more normal cycle in the property market,” he said.

However, some investors still might opt to take their money elsewhere if it isn’t invested in the designated timeframe. Because pension funds traditionally have been under-allocated to real estate, a fund manager that fails to invest money within a designated timeframe only makes the problem worse.

Fund managers also can choose to invest money by buying secondary properties – assets that are not located in core markets – in bulk, but more desirable are the higher risk, higher return opportunistic investments that are now emerging, as strong investment activity in the core markets is triggering sales on more distressed loan and property portfolios. Most of those distressed opportunities will come from Europe, particularly the UK, Spain and Ireland, where there have been the largest debt funding gaps, Vrensen noted.

Few sales of loan portfolios have occurred thus far because the central banks in many European countries have been supportive of commercial banks and haven’t forced them to sell off troubled loan portfolios. That is starting to change, however, with an increasing number of loan portfolios hitting the market.

That is good news for opportunity funds, but managers have to be careful to not let time run out while also not getting too greedy. Given wide bid-ask spreads, managers will need to tread carefully to price deals in such a way that would be favourable to both banks and investors. This may mean that funds ultimately may need to accept slightly less attractive returns, but managers need to be focused on the longer-term goal, which is getting investor money to its intended place.