These days, it’s not uncommon to hear reports of US fund managers either closing on commingled vehicle with less than $500 million in equity commitments or only targeting a few hundred million dollars. The recent news of Morristown, New Jersey-based Normandy Real Estate Partners holding a first close on its Normandy Real Estate Fund III, which is targeting approximately $400 million, and Denver-based JCR Capital closing on $85 million for its $100 million JCR Commercial Real Estate Finance Fund II are a pair of recent examples of GPs raising capital for commingled vehicles with small targets.
Although representatives from Normandy declined to comment on its fundraising activities, market sources familiar with the firm have suggested that the fund manager would prefer closing its fund faster to get its capital to work quickly rather than extend the fundraising period to reach $500 million. “We think smaller is better,” added one source raising a fund seeking $300 million to $400 million in equity.
However, in the private real estate world, is smaller truly better, or is this a case of fund managers trying to put a brave face on not being able to raise larger funds?
According to the executives at real estate consultant Pension Consulting Alliance (PCA), smaller funds actually may be just what institutional investors are looking for. “We think smaller funds would be a positive thing for our institutional investor clients if that were to happen more frequently,” Lindsey Sugar, senior vice president at PCA, told PERE.
David Glickman, managing director at PCA, agreed with his colleague, pointing out that one of the chief advantages to a smaller fund raised over a shorter period of time is having a more precise drawdown for the investor, since a shorter fund offers the investor a better cash management forecast than having the LP get back to the fund manager sometime in the next 36 to 48 months.
“If the funds are shorter, it's more predictable as to when the returns will occur,” Glickman added.
An additional benefit to raising smaller funds faster has to do with opportunities. As far as opportunistic and value-added strategies go, when a fund manager is soliciting contributions, it has a good idea as to what opportunities are available in the next year or two. After 24 months, however, a GP can’t be so sure as to what's going to be out there – or even if there's going to be anything out there – that’s consistent with the fund’s mission.
Furthermore, Glickman noted that, for the last 20 years, many investors have built up their existing portfolios “like paintings that have three-quarters of the subject already identified.” Therefore, the ability to find that last quarter that fits with what they already have through focused, targeted investing is useful. Therefore, the disadvantage of going into a large blind pool could be that, by the time the acquisition period is finished, the LP may wind up with investments that don’t necessarily fit in with its portfolio.
Of course, since not all institutional investors are created equal, there are a few that may not find smaller funds better. In particular, LPs with small staffs may find it difficult having to re-up so frequently. Despite these exceptions, most investors employ a multi-manager strategy for their opportunistic and value-added investments in private real estate.
Ultimately, PCA points out that a GP raising a smaller fund can distinguish itself in an oversaturated market. After all, there are more than 500 funds targeting the same group of investors and, because of the crowded landscape, it can take two or more years before a large fund achieves a first closing. In addition, a GP with a larger fund is taking on considerably more business risk than if its offering period was shorter and smaller.
Perhaps this is a trait of the current real estate investment landscape that fund managers such as Normandy and JCR understand and are acting upon.