EUROZONE: Private equity vs. real estate

Robin Marriott

I have spent the last few weeks taking the temperature of investors, with the most important question being how real estate now fits into their broader portfolios.

Overall, the news seems to be positive, with most evidence suggesting LPs still see property as a long-term asset class.
The magic words are “stability”, “diversification”, “income”, “inflation hedge”, and “maybe a little growth”, which point toward core and core-plus strategies being the most popular at the moment.

LP views are important tea leaves that give clues to the future of an asset class. But we can also learn a lot about where real estate is and isn't headed by examining the direction of its asset class cousin – private equity.

To that end, one could do a lot worse than examine Private Equity International (PERE’s sister magazine), which in November ran a feature mapping out today’s “hot fashions” in private equity and contrasted them with strategies that were “so last cycle”.
The article makes clear that what is in fashion now in private equity isn’t necessarily strutting the real estate runway.

Here’s one example: one of today’s hot fashions in private equity is PIPEs (private investment in public entities). Prime examples include New York firm Warburg Pincus investing €68 million in Premier Foods, a London-listed conglomerate for which Warburg received a 10.3 percent stake in the business. Listed companies need to raise capital either for rescue or expansion and may be reluctant to go down the rights issue road, so the argument goes. Many private equity firms on the other hand have capital to deploy but are short on leverage and keen to get into the ownership base of any company, public or private.
But in private equity real estate, PIPE deals are “so last cycle”.

This is partly because there have been some recent and very public difficulties for those that went into them due to a combination of poor execution, ill timing or lack of control. Carrefour, the French hypermarket chain in which Colony Capital took a stake, is an example.      

It is also partly because real estate investors are seeking exposure to real estate, not the equity capital market. There are still significant discounts to NAV in real estate-rich companies, but no belief that this gap will narrow anytime soon.

Also, real estate values held by large corporations and some property companies and REITs are viewed as being prone to devaluation (due to over-leverage or poor maintenance). As a result, it is unlikely that real estate investors are all that keen to allow their GP to invest in PIPEs.

Here is a second example of where a private equity trend is not evident in real estate: emerging markets. Many private equity investors that once shunned, for example, Asia, have now come to the conclusion that the long term growth potential is too compelling to ignore. Even Brazil, once shunned as the perennial market of the future, is experiencing a renaissance in investor interest.

However, in real estate, there seems to be far more appetite for buying in the established West at the moment. Emerging markets can offer growth, but they are also prone to high volatility (witness Dubai for example). So over time, institutional investors fear that being owners of hard assets may not provide the stability of income they seek. There is a desperate search for yield in the OECD. This is because institutional investors have to provide income to satisfy the outflows from their liabilities (life polices and pensions). Growth is not as important today as it once was.

Although private equity and real estate programmes are often administered by the same team and offered by the same GP group, according to one market veteran, “it seems like we are living on different planets”.  

Yet there are some strategies that do seem to be shared by both private equity real estate and private equity. Take partnering with corporates. Blackstone’s partnership in the UK with British Land looks likes an early example of this. The language used by both parties in press releases is about not just one deal but about future collaboration.

Leverage-lite deals and finally equity infusions into a portfolio company/assets by perhaps raising an annex fund can be seen in both worlds – dressed up as happy language (to take advantage of future opportunities), sometimes disguising the sad reality (our portfolio is in such bad shape we need more money).

Overall, the two asset classes seem to share more in common than they are different. One possible explanation for the current divergence is that private equity real estate is lagging private equity a little. If that is the case, we can look forward to both PIPEs and emerging markets becoming stronger trends in private equity real estate over time.