Friday Letter The denominator effect

Before you take Blackstone’s new $10.9 billion private equity real estate fund close as a sign that 2008 is due to be another record-breaking year for fundraising, consider some inconvenient truths.

First of all, it should be noted that much of Blackstone’s new fund was raised last year. More importantly, there is hard and anecdotal evidence that the fundraising market is slowing. To date this year, approximately $9.3 billion of equity capital have been raised by private equity real estate firms globally, according to proprietary data compiled by PERE magazine. This figure is 25 percent less than the $11.6 billion raised over the same period in 2007.

There is still another side to the story. One fund of funds managing director recently told PERE that he expects the pace of LP commitments to slow in 2008, attributable to what he called the “denominator effect.” As institutional investors have seen the value of their public equity holdings drop, their actual real estate holdings have swollen as a percentage of the overall portfolio.

This rebalancing of investment portfolios is affecting the decision-making of pensions regarding their real estate capital deployment, with investment officers at both large and small pensions starting to decelerate their new commitments. The slower pace of investments, should jolt many a starry-eyed GP from dreams of fundraising grandeur.

This is, however, tempered by continual reports of LPs around the world lifting their target allocations to real estate – recognizing that property is still a solid long-term investment. In the US, for example, the $37 billion Maryland State Retirement Agency and the $58 billion Virginia Retirement System both increased their respective target allocations to real estate in the past month, Maryland doubling its target to ten percent, and Virginia lifting its cap from seven to ten percent.

After all, “Real estate has been the best performing asset class over the past 10 to 15 years,” noted the funds of funds manager.

In fact, 2007 went out with a bang on a record $72 billion in total capital raised by private equity real estate firms around the world – $10 billion of which was raised by Blackstone, which now has the biggest private equity real estate fund in the world.

But hold the shipments of bubbly for the time being. 2008 may be a year for individual stars to shine, but overall the fundraising environment may not be as golden as the year just passed.