Friday Letter Bracing for an equity crunch

A number of next-generation, European-focused opportunistic real estate funds are going to be competing for a finite pool of institutional capital this year. 

A very interesting research paper entitled “The Case for European Opportunistic Investing” was sent out to clients of RREEF Real Estate last month. It rightly puts a finger on indicators that, from a cyclical perspective, suggest 2012 and onwards ought to be an opportune time to source opportunistic investments.

Extrapolating certain data, the research paper even managed to come up with a helpful figure. Between 2002 and 2010, total returns from European opportunity funds were 11.7 percent, beating value-added funds at 4.8 percent and core property funds at 2.8 percent.

The paper is a fascinating read and deserves its own coverage. In the meantime, however, take note of this situation unfolding in Europe: Given that other firms feel the same way about Europe as RREEF and that a number of 2008 and 2009 vintage funds are coming to the end of their investment periods, this year there are, or will be, at least eight firms raising their next-generation Europe/ UK real estate opportunity funds.

To list those firms here would be to risk blowing six months-worth of exclusives for PERE, but the funds already reported on to date include Perella Weinberg Partners and Patron Capital. These two alone aim to hoover up $2.7 billion in capital commitments by the time they are completely done. How much more equity might the other firms out there be looking for this year? As a benchmark, the combined total they raised last time out comes to $8.3 billion.

Given that only around $3.2 billion was raised by Europe-focused opportunistic-style funds in all of 2011 (and that is stretching the definition of opportunistic), one can see why professionals in Europe are talking about an ‘equity crunch’.

The simple question is: how much equity is really going to be available for these firms to succeed in their fundraising targets?

The first challenge for the firms in question is to get their existing investors on board, a significant chunk of which are US endowments and foundations. The problem is that, while as a group they are kind of back in the market making commitments, they: 1.) may not re-up with all the same funds again; 2.) may not write out cheques for the same amount as before; and 3.) are looking at new areas and geographies in which to invest, such as Asia.

At the same time, there are not that many European LPs that want to invest in European opportunistic strategies. It seems that they don’t want higher leverage/higher risk strategies just yet. As a result, it would appear that a number of those funds are going to be smaller than their predecessors.

Roughly speaking, the mindset of potential investors is going to be to separate the funds into three categories. There will be the definite keepers, which include the firms that have performed well in the past (accepting all that has happened). There also will be definite rejects for those firms that performed poorly in the last cycle or were undisciplined in their strategy. Lastly, there will be those firms with whom the LP already has a relationship, but which are neither definite keepers nor rejects. For this category, the LP likely will re-underwrite the firms in question. The effect of that is that some of these firms are surely going to be scrutinised like never before.

As a result, expect the European fundraising environment in 2012 to be a ‘crunch’ in more ways than one.