Great expectations

Most people admit returns are going to be coming down given the rise in cost of debt and the end to cap rate compression - ok, fine. But what have you been telling your LPs? It might be time to get those business books out. By Robin Mariott

Under-promise, over-deliver: That's the advice you'll find in sales and business books sold at the airport.

The alternative to this can be damaging. Having to explain why a particular plan failed to succeed is far more painful than an outcome where diminished hopes are exceeded. Of course, not everyone in real estate subscribes to the view. Donald Trump's new inspirational masterwork, Think Big, Kick Ass, comes to mind.

But in today's uncertain market, encouraging your investors to think small may be the best approach.

Until recently, private equity real estate GPs were able to tell LPs with confidence they would be able to hit 20-plus percent returns in the knowledge that a good opportunity, combined with favourable debt markets as well as cap rate compression should see that promise fulfilled.

For their part, LPs had been keen to listen, and further encouraged by the returns being enjoyed by their counterparts at other pension plans, universities or endowments.

However, the investment game has changed for private equity real estate GPs in a way that is likely to negatively impact returns. A visit to the bank manager to back an acquisition has become a lot trickier since the summer. Instead of reaching for the old term sheet, the one with low numbers on it, the lender is suddenly whipping out a freshly printed sheet marked “Urgent: revised interest rate schedules”.

Once out of the building, the GP then likely picks up a message from a seller who no longer wants to sell because he feels the buyers are offering a knock-down price.

Meanwhile, LPs with an allocation to real estate which needs to be satisfied feel uncertain about what to expect, or even what they want from the asset class. The over-riding suspicion is that returns are going to fall. And if they fall, is private equity real estate still attractive? It is a test of faith.

The capital calls and investment sheets from GPs that were once coming round as regular as clockwork are few and far between today.

Against this backdrop, managing expectations is taking on extra significance, and the issue was highlighted at the Expo Real trade fair in Munich last month, an event at which some 24,800 real estate professionals attended.

In a panel discussion entitled, “Private Equity Investors on the Increase!?” Peter Kasch, an American residing in the UK as managing partner of Catalyst Capital, said some opportunity fund managers are admitting that they will fail to get 20 percent to 25 percent returns. This is not universally viewed as a catastrophe.

“They say, ‘If I get 16 percent, the investors will still be happy and they will come back again.’”

While 16 percent may indeed be looked upon favorably by many institutional portfolio managers, it matters greatly how this revised outlook is communicated.

All the goodwill built up during the good times can very quickly evaporate in more difficult times if investors perceive that bad news is being withheld or misconstrued.

General partners should be aware that culture comes into play when communicating a returns outlook. An aggressive, highly confident approach might work for US investors, but there is a serious question mark over how successful this approach is with European LPs.

Because of deep-seated cultural differences, whereas the US investor might expect to be told by a GP that he will “make it happen,” European LPs are more circumspect. They tend not to appreciate what they view to be a fast-talking New Yorker who promises the earth.

Catalyst Capital's Kasch summed it up nicely: While US investors tend to prefer to be told by a plan sponsor he is “shooting for the stars,” European limited partners “appreciate being told a very direct truth.”

In this era, a more touchy-feely approach between GP and LPs would work better than blustering, which is clearly more appropriate in a rising market. Otherwise, the likely upshot is strained relationships and a greater sense of mistrust.

The experienced fund managers who have seen cycles come and go before know this instinctively, of course, but the younger flashes in the pan may not.

For them, it may be time not to reach for that business book, but for a pamphlet on marital advice. The marriage between an LP and GP is meant to last a long time by dint of strong communications and sound financial practices. The alternative is divorce, which as everyone knows can be extremely costly indeed.

Cordea launches UK alternatives push
Pan-European property fund manager Cordea Savills has launched the UK Property Ventures I Fund, a pre-seeded fund with a £200 million ($400 million) target. The fund will focus on non-traditional areas of the market that have been targeted for intense development by local authorities. According to the firm, the fund will look to acquire land which can be converted into higher value residential use or other uses. The fund will also seek out development situations in mainstream and non-institutional sectors such as nursing homes, social housing or mixed-use sites, as well as value enhancement situations which could involve the longer term piecing together of development sites, the creation of value through lease surrenders, or the acquisition of partly-let or vacant buildings. The fund is targeting a per annum return of 20 percent. It is being seeded with a portfolio of 16 sites which extends to over 7,600 acres of land allocated for development by local authorities, mostly located in the Thames Gateway east of London, an area targeted by the government for extensive growth.

Aberdeen targets Russia
Aberdeen Property Investors is looking to raise €500 million ($709 million) for a new vehicle, Aberdeen Property Fund Russia, in order to invest in commercial real estate across the country. The 10-year closed ended fund will target all commercial asset classes in 13 cities including Moscow and St. Petersburg, according to the firm. It aims to invest in deals ranging from value-added to opportunistic and to deliver 14-18 percent annual net internal rate of return, including a dividend of 5-8 percent. First close is expected sometime in this quarter. The fund launch follows the acquisition of a team from regional fund manager Baltic Property Trust earlier this year and the subsequent opening of an office in St. Petersburg. Ole Dall-Hansen, previously director of fund raising and investor relations at Baltic Property Trust, is heading the team, which is working alongside existing Aberdeen investment managers based in Finland.

Perella Weinberg closes in on debut fund
Investment bank Perella Weinberg Partners was reportedly close to holding a first close on its maiden pan-European real estate vehicle, at the time of going to press, in a vehicle aiming to raise €1 billion. Leon Bressler, formerly the chairman and chief executive of French property investment firm Unibail, is overseeing the effort. The New York-based firm was founded in June 2006 by Morgan Stanley M&A veteran Joseph Perella. It plans to manage a series of vehicles focused on alternative investments funded by $1 billion (€800 million) from its 11 founding investors, including Fisher Brothers, as well as outside capital. Perella Weinberg said last year it would commit some of its own capital to the new real estate fund. During Bressler's tenure at Unibail, which began in 1992, the firm's portfolio grew to more than €9.4 billion ($11.8 billion), making it one of the largest property investment concerns in continental Europe according to market capitalization.