Friday Letter Thinking outside the fund

But this past week has seen a few transactions where LPs have looked beyond the traditional limited partnership investment structures for better economics. This is a good thing, but only if the LPs in question have the resources to act more like GPs.

As more and more capital is earmarked for private equity real estate funds—the number stood at $59.5 billion last year and is on track to hit that level this year, according to data from PERE—some LPs have been looking for ways to invest directly, break out of the pack with high-profile joint ventures or simply double down with additional co-investment capital.

For example, Caisse de dépôt et placement du Québec and hotel REIT Westmont Hospitality Group have set up Cadbridge Investors, a vehicle that worked with another hotel property trust, InnVest, to acquire yet-another lodging REIT, Legacy Hotels, in a C$2.5-billion ($2.4 billion; €1.7 billion) deal.

In the transaction, the high-profile LP picked up a number of landmark hotels in Canada and the US, including the Fairmont Le Chateau Frontenac, the Fairmont Royal York and the Fairmont Empress in Canada, as well as the Fairmont Olympic Hotel in Seattle and the Fairmont in Washington, DC.

Also announced last week was the sale of a portfolio owned by the California State Teachers’ Retirement System and Reno, Nevada-based warehouse developer Dermody Properties. In 2003, the California LP invested $560 million to acquire the remaining logistics properties from a fund sponsored by Lazard Freres Real Estate Investors.

At the time of the initial acquisition, the portfolio consisted of 105 buildings comprising 17 million square feet of space and 415 acres of land—and it made headlines as CalSTRS’ largest real estate investment to date. The joint venture sold the portfolio to Denver-based logistics REIT ProLogis last week for a cool $1.85 billion. By then, the portfolio was stacked with 24.7 million square feet of space and another 518 acres of developable land.

Of course, Caisse and CalSTRS have greater flex in the market than most LPs: But these large investors often influence the trends followed by smaller pensions, endowments and foundations. Where the large, successful investors go, others will surely want to follow.

Then again, these sorts of outside-of-the-box deals aren’t easy: Direct investing, joint ventures and co-investments require all manner of real estate expertise, which many investors might not have on staff. And while plenty of institutional investors want to commit to co-investments, for example, they’re a rarefied opportunity usually reserved for larger LPs.

But for investors of any size that are able to think outside of the fund, impressive returns and new deals with better economics await.