FEATURE: Empty pockets

Up to 785 real estate funds are currently in market globally trying to raise more than $270 billion of equity. The success rate of these funds, by some measures, is just 12 cents on the dollar with GPs spending an average of 400 days in fundraising mode. Yet, despite this, the number of property funds being launched today is almost as high as the levels seen during 2007. Why?

As we enter the final quarter of 2010, PERE takes a look at the state of the fundraising market to answer this, and other questions about how this vintage is shaping up – and how it could ultimately turn out.

Of course, one thing is clear from the outset: 2010 is not going to beat the colossal capital raising years of 2007 and 2008 when commingled value-added and opportunistic real estate funds attracted $85 billion and $74 billion of commitments respectively, according to PERE data. Indeed, as of press time, closed-ended  property funds had closed on just $19 billion of capital, compared to the $30 billion corralled in 2009. It seems possible, therefore, that fundraising in 2010 will be even worse than the lows hit last year.

For some industry professionals PERE has spoken to that might not be the case. They wonder whether GPs will experience a surge of capital deployment by investors in the final three months of the year, as LP liquidity constraints ease and certainty over market conditions continues to strengthen. It is certainly true that the number of funds holding interim and final closes has steadily increased over the past six months as institutional investors, in particular, once again start to make fresh commitments to new vehicles.

Although many limited partners are ready to invest, there’s just no rush.

Martin Rosenberg, principal,
The Townsend Group

But, as Martin Rosenberg, principal at Cleveland-based consultant The Townsend Group, notes: “Although many limited partners are ready to invest, there’s just no rush. Many of them already increased their real estate exposure through open-end funds at the beginning of the year, while some have been focusing on separate accounts.”

With global property transactions in the second quarter of 2010 down by roughly two-thirds from the same period in 2007, fund sponsors are struggling to invest whatever equity they do have. Existing closed-end funds tracked by Townsend have nearly $80 billion of undrawn equity, with open-end funds having billions more.

Why, therefore, should LPs feel compelled to make new commitments when opportunities of real quality are few and far between? “We have seen transaction markets start to move a little this year, but many LPs want to see a strong pipeline before making a long-term commitment and beginning to pay a management fee,” Rosenberg says.
So what are the trends for global fundraising as we enter the final straight of 2010?

Rising tally

The main observation is that the number of funds being launched in 2010 is not set to be significantly lower than the volume of vehicles which entered the market in 2007. According to Townsend, based on the number of closed-ended real estate funds launched to date, 2010 could see more than 250 vehicles enter the market targeting a diverse set of strategies globally. In 2007 and 2009, the number of funds launched was an estimated 260. The peak was seen in 2008, when the number of funds launched rose to about 325.

Anecdotally, it feels as though an even greater number of funds are being launched in what could be described as one of the toughest fundraising environments to ever face the real estate investment industry, with news of spin-outs and new players entering the market on an almost weekly basis.

[We are] in a fundraising environment, which I would argue, is the second toughest I’ve experienced in my career.

Steve Coyle, chief investment officer,
Cohen & Steers’ private real estate multi-manager group

Steve Coyle, chief investment officer for Cohen & Steers’ private real estate multi-manager group, argues the impression of even greater numbers of funds coming to market is not illusionary. His firm is currently tracking 785 real estate funds in market targeting an estimated $273 billion of equity commitments. The funds comprise distressed, opportunistic, value-added property vehicles as well as debt, core and core-plus, fund of funds and secondaries funds.

He says Cohen & Steers’ total database of real estate funds, which includes vehicles that have already closed, is now just shy of 3,000. “It’s really interesting to observe that four years ago we saw around 400 funds in market,” he says. “Now we are tracking just less than 800. And this in a fundraising environment, which I would argue, is the second toughest I’ve experienced in my career.”

The first, Coyle explains, was during the RTC days of 1992 to 1994 when “capital got raised, but not very much,” he says, adding: “It was very tough, but the best time to put your money out was 1992 to 1996. It also just happened to be one of the most troublesome periods for raising opportunistic capital.” A situation that almost mirrors today’s real estate investment world.

Townsend is also tracking a significant number of closed-ended real estate equity and debt vehicles in market globally: 404 at the time of press. These vehicles, targeting value-added, opportunistic and debt strategies worldwide, but not including open-ended or multi-manager, are seeking more than $135 billion of equity.
More than 70 percent of the funds that Townsend tracks are focusing on the developed Americas, primarily the US. Of those, almost one in five are dedicated debt vehicles, rather than just vehicles able to employ a loan-to-own strategy.

Capital chasing

A plethora of real estate vehicles hitting the fundraising trail, however, is not an indication of how much capital is actually being raised – and closed upon. Indeed, Coyle and Rosenberg both agree that the amount of capital being sought by fund sponsors is widely different to what is actually being secured from LPs.

According to Townsend data, real estate equity and debt funds with initial closings targeted for 2010 have closed on $5.8 billion of equity so far, yet are seeking nearly $87 billion. The 404 funds currently in market are targeting total equity of $121.6 billion, yet have corralled just $14.3 billion to date – just shy of 12 percent of their original targets. 

The 404 funds currently in market are targeting total equity of $121.6 billion, yet have corralled just $14.3 billion to date – just shy of 12 percent of their original targets.

Coyle sees a similar story. “There will be a very large number of funds that will simply be unsuccessful.” Although reluctant to put a figure on it, he expects just a quarter of all fund managers currently in market to raise capital.

Coyle adds that around two-thirds, or even three-quarters, of the industry could fade away over time, noting that in the past 18 months he has seen 88 funds in market shelved or postponed. Rosenberg declines to predict how big the industry consolidation could be, but adds: “It will be fewer than we have today.”

Coyle quickly points out though that even if managers are able to raise capital today, and in the near term future, they won’t secure the amount they set out to achieve.

Target practice

One reality of fundraising in 2010 is that oversubscribed funds are a rare occurrence. Also initial fundraising targets have decreased steadily since 2005, according to Townsend, with the 75th percentile target equity raise just $500 million – down from $991.3 million during the peak of 2007. Even the smaller funds have been hit, with the 25th percentile fundraising target $143.8 million in 2010 compared to $250 million in 2007.

Lone Star Funds became the most notable casualty of this downward pressure on fund targets in August, when it slashed the target for its second real estate opportunity vehicle from $10 billion, to just $4 billion. Sources at the time said the decision had been made “due to the current challenges in the marketplace from a fundraising perspective”.

If even brand name platforms are struggling to raise equity, therefore, how difficult must it be for everyone else?

It takes an average of 400 days, according to Townsend, although for some funds it can be 800 days and more.

“GPs that successfully raise capital will include some brand name players as well as new firms with strong pedigrees that can make it through a very stringent due diligence process,” says Mike Romo, director at Hawkeye Partners, which seeds emerging private equity real estate managers.

“Fund sizes on successful raises will likely be lower than what we saw during the bubble; however, what is most relevant is that on a fund by fund basis, the size is right for the targeted opportunities and the resources of the sponsoring firm.”

What is clear is that raising a real estate fund today is taking a long time. In fact, it takes an average of 400 days, according to Townsend, although for some funds it can be 800 days and more.

“People have an expectation that it will take 12 months to 18 months to raise a fund,” says Coyle. However, in many cases the amount of time a fund spends in market could be dictated more by financial considerations, rather than investor appetite. “For some, the end of marketing will be when a GP’s capital wears out, or until their resolve wears out – whichever comes first.”

Irrespective of the statistics, though, the private equity real estate fundraising market isn’t all doom and gloom. Rosenberg makes the point that despite suffering heavy declines in the valuation of their property portfolios, institutional investors haven’t turned their back on the asset class.

“They have not adjusted their strategic goals or allocations in response to the downturn,” he says. As a consequence, many LPs are heavily underweight to real estate. “Simply to invest in line with their strategic allocations, institutional investors are going to have to put additional capital to work, and many of them will need to use some closed-ended funds to access the markets efficiently.” It is, Rosenberg says, “just a matter of time”.

To read the full story, and to see fundraising data charts from The Townsend Group and Cohen & Steers, see the October issue of PERE magazine.