Investors face a Catch-22 with fund extensions

The private real estate industry remains stuck in a more than decade-long trough for both fundraising and transaction activity.

Global investment volume fell by approximately 18 percent year-on-year in Q1 2024, marking a 12-year low, according to commercial real estate broker Savills.

Meanwhile, only $19.8 billion was raised during the first quarter of 2024, the lowest Q1 fundraising total since 2011, when $15.2 billion was corralled, according to PERE’s latest fundraising report.

In Savills’ latest Global capital markets week in review published last week, the firm’s researcher Oliver Salmon pointed to a likely reason for both – closed-end fund extensions.

The current decline in market liquidity is demonstrated by a low turnover ratio, which measures investment as a total share of market size. The turnover ratio for global commercial real estate markets fell from nearly 8 percent in 2022 to 5 percent in 2023 – the lowest level since 2009, when it dropped below 4 percent, Savills recorded.

For Salmon, fund extensions are likely “a large contributing factor” to the low turnover ratio. Such extensions are likely to be occurring “with increased frequency,” he wrote.

And yet investors largely have not found such extensions to be problematic. As PERE explores in its May cover story, published this week, investors sitting on limited partner advisory committees have agreed to fund term extensions in the current market environment. In approving such extensions, they acknowledge many managers have faced challenges in finding buyers at the right price for the remaining assets in the fund.

In fact, Navid Chamdia, head of real estate investments at sovereign wealth fund Qatar Investment Authority, regards fund term extensions as the least contentious issue that he discusses as an LPAC member. He explains that the investor is “willing to accommodate and be understanding” if it is not an optimal time for a manager to exit an investment.

Most investors have similarly practiced patience during the protracted market downturn. But being accommodating has its own damaging consequences, both for the limited partners themselves and the overall market.

One is the lack of distributions for limited partners in closed-end funds. As Sajith Ranasinghe, managing director of global real estate at The Church Pension Fund, the pension fund for The Episcopal Church, said at the PERE America Forum in November, “We’d like to always get more distributions, but that’s obviously outside of our control.”

What is more: distributions are worth more today than they were a few years ago, given the greater number of compelling opportunities at this point in the market cycle, he noted at the time.

Fewer than expected distributions also have negative repercussions for fundraising, as fewer fund exits means investors have less capital to commit to newly launched funds, according to Salmon.

While limited partners are not in the driver seat in terms of when fund investments are realized, they have more control over distributions than Ranasinghe would suggest. Investors, after all, always have the option to not approve fund extensions.

The question, then, is what is more painful for investors: the potential losses arising from managers being forced to sell; or missed deployment opportunities from having capital locked up in funds for longer than expected?

It is clear either option will create some pain for investors. But given how commonplace fund extensions are becoming, we believe we have our answer.