Opinion

Friday Letter The curve in the road ahead

Attend any private equity real estate conference of late and every delegate will tell you the industry is at an inflection point. The collapse of the credit markets has made most deals difficult to close. Investors are reassessing their portfolios. Many now predict a shakeout of managers as the proverbial chaff is separated from the wheat. And, most importantly perhaps, the geographic focus of many real estate investors, including those using private equity fund structures, is undergoing a fundamental shift. 

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Emerging markets such as China, India and Russia have been attracting investors since long before the current market dislocation. However since last summer, equity sponsors and their investors have renewed their emphasis on these markets with vigor.

Just look at the recent report from Real Capital Analytics about investment activity globally. Overall the picture is not for the fainthearted. During the first quarter of 2008, there were 46 percent fewer deals compared to the same period in 2007, with the US and Europe most affected by the slowdown. In the Americas region, quarterly sales were just $49 billion against $149 billion 12 months earlier. In Europe sales fell from $95 billion in 2007 to just $56 billion in the three months to April this year.

Yet while investment activity went into freefall in the US and Europe, the emerging markets were telling a different tale. In Asia, the value of deals increased 27 percent, driven in part by developmental investments in China and India. Indian retail reported a 7,500 percent increase in sales in the first quarter of 2008, to $1.5 billion. Compare the statistics like-for-like and it’s clear that deal volume in the US and Europe still massively outweighs that of the emerging markets. Nevertheless, there is no doubt that capital is moving continents.

A look at fundraising statistics confirms this. Research by New York-based fund of funds Clerestory Capital shows there were 128 opportunistic real estate funds raising less than $1 billion in the first quarter of 2008, up from 107 funds in the third quarter of last year. The majority, 51 in total, are targeting the Americas, with 24 looking to Europe. Asia though has attracted 47 funds.

Proprietary data from PERE paints a similar picture. It shows general partners have closed on $35.5 billion of commitments to date, of which almost $11 billion is earmarked for the Americas (notably the US), and almost $15 billion targeting Europe. Asia-specific funds have closed on $5.2 billion, with Australia’s MGPA taking the crown this week for raising the largest dedicated Asia real estate fund ever on $3.9 billion. Yet there is another $30 billion worth of funds still in the market.

Current conditions will no doubt make life harder for some, particularly first time funds with little track record or definitive returns to point at. However the changing direction of global capital flows in and out of private equity real estate funds is one of the more exciting stories to emerge from the credit crunch. Many institutional investors are changing direction, and private equity real estate managers focused on emerging markets stand to benefit significantly.