FEATURE: Real estate sentinels

Where is all the money nowadays? It’s the first question a placement agent is asked when meeting a GP. And after almost three years of an extremely tough fundraising environment, perhaps it’s an inevitable question to ask.

A majority of blind-pool fund managers today are nursing 2007 and early 2008 vintage vehicles that are set to either run out of capital or run out of time thanks to rapidly expiring investment periods. For these GPs, the second half of 2011 and 2012 will be a time when they need to come back to market if their brand is to survive in the long term.

For placement agents, however, the more appropriate question a GP should be asking is whether they are actually marketable in today’s market. Gone are the days when a fund could close near target based on little more than a halfway coherent strategy and fund managers who scrubbed up well. LPs in 2011 are much more diligent – and picky – when it comes to investing their capital. By default, so are placement agents.

You’ve got to figure out where the talent for the next decade lives. It’s a very important part of how we are all building our franchises in the private equity real estate space.

Michael Hoffman, president and partner of San Francisco-based Probitas Partners

After seeing their own industry shaken by LP illiquidity, consolidation and scandals such as the US pay-to-play furore, placement agents globally need to be smarter in how they do business. Robert Weaver, managing director at Morgan Stanley Real Estate’s placement arm, says: “Placement agents are trying to do more with less. The overall business is down, and the number of people in the business is similarly down. When that happens, you need to work smarter.”

Of course, being smarter will mean a plethora of different things to different people. For some, it could be about targeting LPs just starting out with their real estate allocations or trying to secure larger capital commitments from a smaller number of investors. For others, it could be a matter of reverse equity placement, whereby LP capital and ideas for investment are taken directly to GPs rather than the other way round.

However, what it does mean universally for placement agents is the need for them to be selective as they search for the next generation of private equity real estate success stories. Whether those success stories are the next set of global brand names, the best student housing fund in the UK or the most consistently top-quartile GP in Asia, choosing “best-in-class” managers will be vital if the placement agents themselves are to ready their businesses for the long haul. Unfortunately, placement agents are kissing “more frogs than ever” in their search for princely GPs, as one veteran of the industry, who declined to be named, describes it.

“You’ve got to figure out where the talent for the next decade lives. It’s a very important part of how we are all building our franchises in the private equity real estate space,” adds Michael Hoffman, president and partner of San Francisco-based Probitas Partners. However, he concedes the task can sometimes be like trying to find a “needle in a haystack.”

Diligent details

Most placement agents are meeting and speaking with between 100 and 250 managers per year. Of those managers, fewer than 20 percent will make it into a placement agent’s due diligence process, while no more than a handful ultimately will win team approval and be brought to market.

Today, that due diligence process is more thorough than ever as placement agents dig down into past and current performance, historical investment activity, legacy issues, fund- and property-level cash flows and leverage, fund strategy and even a GP’s valuation methodology. “One of the things I want a GP to be able to demonstrate to LPs is the discipline they showed from the apex of the market in 2007 to early 2008,” says Hoffmann. “I ideally want them to be able to prove they did very few investments but also, when they did make offers on deals, that they were off the top numbers by 20 percent to 30 percent.”

Part of the job of a placement agent is to take on things that are going to be successful and to make sure they are a success when you do. That means you’ve got to be more discerning about what you take on.

Robert Weaver, managing director at Morgan Stanley Real Estate’s placement arm

GPs will – and did during the course of this feature – criticise placement agents for only backing fund managers that have the greatest chance of gaining traction in the market. Few placement agents can argue against such a statement. It’s simply the nature of their business. “Part of the job of a placement agent is to take on things that are going to be successful and to make sure they are a success when you do,” says Weaver. “That means you’ve got to be more discerning about what you take on.”

In searching for the next generation of talent, though, placement agents also are responding to the evolution of the market. The most dominant private equity real estate names globally today grew out of the last distressed cycle, namely the US savings and loan crisis of the early 1990s. The industry is again facing such a period of transition, according to Bill Thompson, managing director of Greenhill’s Real Estate Capital Advisory group. “It’s an interesting and exciting time for the industry, as you will see a transition in the brand names in the business,” he says, adding that a growing number of mid-size managers will step up to be the next generation of industry leaders.

Part of the search, of course, also will be about targeting firms who might be two years away from their next fundraise. “It’s all about building relationships with LPs and GPs and understanding what they’re thinking about and what they’re doing, not just at the point of the fundraise but well before that time,” adds Alan Pardee, managing partner of Mercury Capital Advisors.

Of course, there’s no secret formula for what will be a best-in-class GP, or which ones will gain the most support from LPs. For some, it’s operators over allocators and local strategies rather than broad mandates, while for others it’s joint ventures and club deals over funds or vice versa. “The tale of this market is about the haves and have-nots,” says one of Thompson’s fellow managing directors, Walter Stackler. “The fundraising market is improving and there will be a number of GPs who hit their target fund size, but there also are going to be many who only raise 50 percent or less of what they expected and take twice as long to do so, if they are successful at all. For placement agents, that means continuing the important focus on manager selection and ensuring we target the investors most likely to be interested in our offerings in the first place.”

Paying the doorman

For all the diligence and work that placement agents do in finding and working with real estate fund managers, there is one area where the sector comes under heavy fire: fees.

One large household name that has turned to a placement agent to help it target new US and international investors after raising more than half a dozen property funds itself.

Ranging on average from 1.5 percent to 3 percent of committed capital, placement agent fees can often exceed a fund’s management fees, prompting some GPs to ask whether external fundraisers can bring true value to a fund. “They can open doors for you and, when it comes to the PPM and coordinating the roadshow, they take care of the entire process. But that’s a rather expensive concierge service, don’t you think?” says one GP only half-joking.  “When you’re a mid-sized firm on Fund III or IV with a healthy pool of existing LPs, is there any need to hire an external door opener?”

For some, the answer will be a definite no. Many private equity real estate firms will choose to raise capital solo or perhaps use an agent to raise money only in geographies where they have no LP relationships. For many others, though, placement agents will be crucial.

Indeed, PERE was told of one large household name that has turned to a placement agent to help it target new US and international investors after raising more than half a dozen property funds itself. The tougher fundraising market was cited as the primary reason for its decision.

The criticism regarding fees often centres on the fact that placement agents usually take their commission in bulk once a final close has occurred, or in some cases deferred over a number of years. Michelle LeRoy and Anthony Biddulph, both of Spearhead Capital Partners, argue that placement agents could be missing a trick in aligning themselves 100 percent with GPs. The firm, founded in 2009, has adopted a different structure of taking a smaller fee from the fundraise but then taking a percentage of the carried interest in the fund, as well as reinvesting some of their fees back as co-invest in the vehicle.

Other placement agents have adopted this strategy as well, PERE sources say, and it’s certainly a case of placements agents putting their money where their GP’s mouth is. But even this comes under fire in that it could encourage agents to back GPs with higher-risk strategies promising higher returns.

What one GP argues instead is for placement agents to take a smaller fee but tie fund managers in for longer. “What I don’t understand about the model is that placement agents are putting themselves out of business in the long run,” the opportunistic manager says. “The more successful a placement agent is, the more likely it is that a GP will raise capital on their own in the future.”

Presented with the GP’s argument, one placement agent shrugs his shoulders and quietly responds: “That’s the nature of the business I’m afraid.”

Show me the money

That just leaves the question of where all the money is and how quickly will it get raised. Capital today is coming from many different pockets, according to Mercury Capital’s Pardee, with certain LPs ready and willing to make decisions now compared to others who are still reassessing their portfolios.

What is more certain now is the time frame. “If it was 2009, my answer would have been 24 months to forever,” Pardee says. “It’s good news that we’re no longer in that zone.” However, he argues it’s still tough going out there for anyone raising a fund. “In April 2011, I’d have to say in all cases budget at least a year, but expect between 15 months and 18 months,” he adds. “The fundraising market is certainly not easy, but it is open for business.”


The secret diary of a placement agent

The job of a placement agent is not just about raising capital from LPs; it also involves comprehensive due diligence on fund managers set to come to market, advisory work relating to fund formation and the strategic positioning of GPs. PERE presents an untypically condensed and somewhat hypothetical day in the life of a placement agent

7:30 am
Put children on school bus before heading to the city for a breakfast meeting with the director of real estate investments at a corporate pension plan. Chat about their existing portfolio and future strategic direction. They just made two commitments outside the US and are looking to Asia for other deals. Talk about two mandates in Asia we have and agree to send over fact sheets on them.

9:30 am
Arrive in the office and speak with the London team about active mandates and potential new mandates in Europe. One of our value-added fund managers is on target for a first close of €350 million in next 14 days after 60 percent of the existing LPs re-upped.

10:15 am
Weekly conference call with a US-based GP. Discuss feedback from investor meetings held over the prior week and follow-up required for LPs that have expressed interest in further due diligence. Also, discuss recent comments received from investors that have reviewed the fund’s limited partnership agreement. Discuss potential strategies to help the parties find a middle ground.

11: 45 am
Early lunch comprised of a sandwich in front of my computer while catching up on emails. A Netherlands-based LP has sent email confirming they’re willing to meet with one of our mid-size Asia-focused GPs, marking the final slot on the European-leg of an upcoming roadshow. This particular four-day trip will cover eight LPs in total in the Netherlands, Switzerland, Germany and the UK. Also get a chance to review preliminary offering materials for an upcoming mandate.

1 pm
Leave office to head to meeting with a potential GP. During the meeting it becomes apparent that this sponsor is not ready for a fundraise or programmatic venture. Politely explain that our team meets with more than 200 prospective managers each year and only takes on eight to 10 new assignments.

2: 45 pm
Call and email potential LPs about a recently launched fundraise for a Brazil-focused commingled fund. Also call a large public pension LP who is considering a programmatic joint venture and discuss the state of the secondary market after they reveal they are considering selling a sizable portfolio of secondary interests. Agree to talk again next week in more detail, and with a list of possible buyers.

4:15 pm
Take a break from calls and emails to discuss logistics with our roadshow coordinator on an active US opportunistic mandate to determine the best schedule to meet investors in the Southeast and mid-Atlantic regions of the US. A colleague comes into my office to confirm they’ve informed a fund manager, which is planning for its third fund, that we’re declining the opportunity to work on the fundraise given the weak performance of its second fund and the unlikely support of existing LPs.

5:30 pm
Call a potential GP client, on whom we’re in the early stages of due diligence and just about to finish background checks. Beyond following up on the due diligence, we have a detailed discussion of market terms and best practices, as well as exactly what investors expect in relation to transparency and reporting today.

7 pm
Head to the airport for a flight to the Midwest for meetings with a GP and a couple of LPs tomorrow. While waiting for the flight, join an introductory call between Asia colleagues and a prospective GP in China. Also have a follow-up internal call with colleagues to discuss background and feedback on the GP and the next steps. Asia colleagues fill us in on recent dialogue with LPs in China, Singapore, Korea and Japan. 

10:30 pm
Arrive at destination and take a cab to the hotel. Set alarm for 5:45 am, giving enough time for a work-out and breakfast before joining meeting with a US-based GP and a Midwest public pension LP at 9 am. Later that day, it’s another flight to host an investor roundtable with a group of six major US LPs, both corporate and public, to discuss market trends.