Funds forecast: gloomy

Next year promises more challenges for fund managers to invest capital and investors to meet return expectations, as well as a continuing shift toward increased investor reporting.

You know the end of the year is approaching when the major global accounting firms start coming out with their annual outlooks on real estate trends. However, judging from this year’s batch of findings, it doesn’t seem like there’s much reason to get too excited about 2012, at least from the perspective of private equity real estate fund managers.

With real estate experts predicting an oversupply of equity capital and an undersupply of debt financing in the market in 2012, opportunity funds with significant amounts of dry powder will continue to struggle to find attractive deals with which to invest capital, according to the Emerging Trends in Real Estate 2012 report released by PwC and the Urban Land Institute this week. Meanwhile, opportunistic investors are likely to further lower performance expectations, with even mid-teen returns appearing to be out of reach as risk increases from weak supply and demand fundamentals, the report said.

Speaking of investors, it seems they have successfully been negotiating for more favorable deal terms, as funds have produced lower returns relative to pre-2007 levels, according to another report, Trends in real estate private equity, which Ernst & Young is slated to issue on Monday.

In addition, the trade organisations representing limited partners have been pushing for more frequent and detailed reporting, including clearer definitions for fee structures in fund documents, which has helped to establish more consistency and a stronger framework for investor reporting. More transparency in reporting is a clear trend, as “the sophistication of advisors and the role of pension fund advisors raise the level of expectations every year,” wrote Mark Grinis, E&Y’s global real estate funds leader, in the report.

E&Y predicted more changes in store for LP reporting, especially as new regulations impacting the real estate funds industry – such as the Dodd-Frank Act and Alternative Investment Fund Managers directive – take effect. Expect additional disclosures in assumptions, fair value criteria and debt analysis, among others.

One concern for limited partners is that, while better investor reporting helps to assure that investments are being managed properly, fund managers could get bogged down with complying with the new regulations and the related rise in costs, which could affect the speed with which managers can invest capital and, ultimately, the size of investor returns.

A piece of good news, however, is that fund managers that are required to register may become more marketable to investors, which can only help with the flow of capital into real estate funds. It’s a silver lining amid a gloomy outlook.