Friday Letter Celebrity syndrome

During an earnings call this week, The Blackstone Group, which is still raising capital for its current global real estate opportunity fund, mentioned that a new global real estate fund already is on the horizon. Tony James, president and chief operating officer, said “we’ll be back very soon” with a new global real estate fund given the firm’s current pace of real estate investment, which saw it deploy about $7.6 billion of investors’ capital last year. “Frankly, I don’t think we can raise fast enough to sustain that pace.”

So far, the New York-based private equity and real estate giant has closed on more than $6 billion in commitments for its latest global real estate fund, Blackstone Real Estate Partners (BREP) VII, which is on pace to become the largest real estate fund in the world. Indeed, BREP VII is expected to surpass the previous fund in the series, BREP VI, which closed on $10.9 billion in February 2007, James noted. More than likely, the firm will achieve this milestone.

Recently, PERE heard BREP VII referred to as a ‘celebrity’ fund, in that Blackstone is enjoying success with investors based on the firm’s historical track record and investors’ belief in safety in numbers. Indeed, since the global jolts emanating out of Europe and the US last summer, investors have tapped the brakes on new commitments to funds. As a result, they are moving much more cautiously and deliberately, sticking primarily with larger ‘safe’ firms and funds that they know well.

Blackstone certainly fits that large, well-known bill, although it is easy for investors to romanticise the firm’s track record. It is true that firm has generated some impressive returns over its history through the BREP series of funds. More recently, returns have continued to be good, but have they hit the expected level for a fund positioned as opportunistic?

Documents from the Pennsylvania Public School Employees’ Retirement System (PSERS), which agreed to commit $300 million to BREP VII in June, provide a detailed look at Blackstone’s track record and that of its BREP funds. The data presented there suggests that perhaps returns have not achieved their expected level. 

According to the documents, the first BREP fund in 1994 generated a net IRR of 39.7 percent, Blackstone’s best performance to date. Funds II, III and IV achieved lower, but still respectable, net IRRs of 18.7 percent, 21.5 percent and 15.8 percent, respectively. Funds V and VI, however, regenerated net IRRs of just 8.3 percent, a good deal below the level of return often considered opportunistic.

Of course, everything is relative. BREP V and VI were raised in 2006 and 2007, respectively, fund vintages that were notoriously horrible across the board due to firms investing at the height of the market just prior to the global financial crisis. Therefore, returns better than 8 percent could be considered pretty good, particularly when most firms generated negative returns and a few were wiped out completely. Still, it may be slightly disingenuous to call them opportunistic, although Blackstone still has time to improve upon those results.

The return data presented by PSERS also supports industry research, which shows that the more funds a firm raises and the larger those funds become, the lower returns get and the less likely they are to hit their return targets. Indeed, that argument often is used by those in the industry that support investment in emerging managers and first-time funds.

There are exceptions to every rule, and Blackstone, while not disproving the industry research, has done better than most. The question is whether the firm’s ambitious investment plans for 2012 and beyond, and the resulting need for even more capital, will lead to the reemergence of opportunistic performance or a continuation of solid but not stellar returns.