EY: Record amounts of dry powder hurt fundraising

Having massive amounts of available capital was not necessarily a boon for real estate managers last year, London-based advisory services firm EY said in its 2017 global market outlook report, Trends in real estate private equity.

Closed-ended property funds had record amounts of dry powder as 2016 drew to a close, Mark Grinis, global real estate fund services leader at EY, wrote in the report. Globally, managers held $239 billion of capital to deploy, up from $210 billion in 2010 and significantly higher than the $132 billion in available capital a decade ago, the report said.

The real estate fundraising environment has remained robust in recent years as the full range of investors – including pension funds, insurance companies, sovereign wealth funds and family offices – have increased their allocations to asset class, often between 8 percent and 10 percent of their total portfolios. A big driver of investor interest in real estate has been the asset class’s higher returns relative to the negative yields that many fixed-income investments now generate. Such interest has consequently led large managers such as Blackstone to raise record-breaking property funds over the last two or three years.

At the same time, the significant amount of excess capital allocated to real estate has also been problematic. “With so much capital directed toward real estate investment globally, managers face high levels of competition for the few deals that come on the market,” wrote Grinis, who is based in EY's New York office. “While this has the effect of pushing up real estate valuations in most markets worldwide, a gap in price expectations between buyers and sellers is either putting a brake on transactions getting completed or leading to investors seeking alternative places to deploy their money.”

The slowdown in transaction volume also has resulted from global volatility. “The problem is when you enter an environment of uncertainty,” he noted, in an interview with PERE. “That uncertainty has the general characteristic of throwing some sand in the gears, which it has. You couple that with high amounts of dry powder, and it slows down transaction volumes and as a consequence, it slows down fundraising.”

Indeed, 2016 fundraising slipped 15 percent from 2015 levels to $104 billion, according to the EY report.

One major area of uncertainty is the impact of President-elect Donald Trump’s policies, particularly tax reform, on the US real estate market. “Even in the first 100 days, it’s highly unlikely we’ll have enough visibility to remove a cloud of uncertainty,” said Grinis. “That’s a key component of why I think there will be softness in fundraising.”

Once again, however, that softness will be concentrated primarily with midsized real estate fund managers, he noted. “The large managers continue to have successful funds and successful monetization,” Grinis said. “The fact that the ‘super-platinum’ continue to get market acceptance by institutional capital has not abated. I think it’s the firms in the middle that may be experiencing softness, may be having a hard time.”

Meanwhile, new managers actually have enjoyed a more receptive investor market. “It has been difficult to enter the market as a new manager, but we see cracks opening up in that regard,” Grinis said. “Small managers with an attractive investment thesis are catching the eyes of certain LPs.”

He added: “Before, new managers couldn’t get a phone call. That dynamic has now improved.”