Friday Letter LPs want simple, LPs want safe

These days, what real estate investors want more than anything is to get out of the j-curve with fast and steady cash flows, rather than using leverage and taking risks. That was the message conveyed at the start of this week’s PERE Summit in New York.

Speakers in an early session entitled “Right Here, Right Now: Global real estate markets today,” agreed that, on average, LPs are more focused on seeing quick realisations on their investments than they were prior to the global financial crisis.

“What investors are looking for is cash flow,” said Ronald Kravit, head of real estate investing at New York-based Cerberus Capital Management. “That is the major focus of investors today. That’s different from about five years ago, when capital appreciation was okay.”

Kravit added that Cerberus’ focus has always been to get cash back to its investors as quickly as possible, so the firm hasn’t had to change its investment model to accommodate this recent change in investor appetite, but nevertheless the shift was there.

Christopher Graham, managing director of acquisitions at Starwood Capital Group, echoed Kravit’s sentiments, adding that he has noticed that the Greenwich, Connecticut-based private equity real estate firm’s investors also “don’t want to take much risk and don’t want as much leverage.”

As an example, Graham noted that his firm’s last vehicle, Starwood Global Opportunity Fund VIII, was approximately 32 percent levered and fully invested. Starwood asked Fund VIII’s investors how they’d feel about bringing the leverage up to roughly 50 percent but still keeping it relatively risk-free. The LPs said no.

“They didn’t want us to stretch as much for huge returns,” Graham added.

The panellists’ consensus was that keeping things simple and keeping things safe appear to be two major objectives that LPs have when investing in the current climate. This would explain a number of institutional investors’ recent increased demand for stable, income-producing assets.

It seems there is a dynamic where people do not want much risk.

As LP preferences go, this post-crisis conservatism looks distinctly of its time. It’s a telling reminder just how much investor confidence has been dented since 2008.

The question now is, how long until investor appetite for risk bounces back completely? For bounce back it will, once the recent wounds have healed, and the low yields that come with risk aversion become intolerable.

Clearly managers like Starwood are ready to up the ante now. Sternlicht’s men may have been rejected once, but they will come asking their LPs’ permission for more gearing again. It is a certainty that at some point, the answer is going to be yes.