Friday Letter The pool is shrinking

Last year, in one of the toughest fundraising environments ever, GPs raised only $30bn in capital. 2010 could be just as difficult – especially if more investors opt out of the commingled fund model. 

With just $30.4 billion of capital raised for value-add and opportunistic private equity real estate funds in 2009, it’s fair to say fundraising in the past year was austere.

Compared to the peak of 2007, when global fundraising efforts corralled more than $85 billion, 2009 was down by roughly two-thirds. Even judged against 2005 standards, 2009 fundraising for closed-ended, commingled property vehicles was no bonanza. In 2005, when PERE first started collecting data, GPs raised some $37.4 billion in capital commitments.

No question, the past year was a humbling one for all concerned. And managers are craving fresh funding. According to PERE data, there are currently more than 240 real estate equity funds in the market trying to raise capital.

As limited and general partners look ahead to 2010, though, what will the fundraising landscape look like? Will investors continue to back the private equity real estate fund model in force, or will they move increasingly to ad-hoc structures, separate accounts and direct deals? Larger institutional investors have certainly warned of this possibility over the past year.

During 2009, some fund sponsors responded to the declining appeal of the commingled fund by pushing alternative models instead. Brookfield Asset Management was a case in point when, in August, it unveiled its $5 billion turnaround consortium involving a handful of large international pensions and sovereign wealth funds investing between $300 million and $1 billion each.

Such moves though have prompted concerns among managers that the industry will bifurcate between those investors with enough clout and savvy to go increasingly direct, and those investors which simply don’t have the resources to do much more than indirect property investing.

Although the number of institutional investors that opt to bypass the commingled fund route will likely be small compared to the total size of the real estate investment community, they will nevertheless represent a fairly significant portion of the available capital. As this capital is directed elsewhere, fund sponsors will find themselves fishing in a shrinking pool with more GPs angling for fewer dollars.

Of course there won’t be a complete retreat from commingled funds, even among large LPs. As one such investor stressed to PERE this week, their group might still consider some fund investments – but on a much more limited basis. “It’s about liquidity and control,” the investor explained – implying that funds aren’t great at providing either.

For general partners the trend is not a helpful one. It is yet another reason why no-one is expecting fundraising for closed-ended, commingled property vehicles to jump back to the heady days of 2007.

Fundraisers make no mistake: your task is fraught with difficulty, and 2010 will not deliver much easing at all.