EUROZONE: Equity crunch

A new form of entertainment in European private equity real estate has arrived. A bit like one of those reality TV shows where celebs are thrown into the jungle, the new game involves watching established opportunistic fund managers compete against each other in the race to raise a fund. Who will survive?

According to a collection of sources, there already are – or soon could be – at least a dozen fund managers in the market by the end of this year with next-generation opportunity funds. They include AREA Property Partners, Europa Capital, Orion Capital Managers, Meyer Bergman, Mountgrange Investment Management, Patron Capital, Peakside Capital, Perella Weinberg Partners, The Carlyle Group, Tristan Capital and RREEF Real Estate, a firm that apparently is raising a global vehicle but with particular emphasis on Europe. That is not to mention European debt funds being raised by opportunistic managers such as Starwood Capital Group and Fortress Investment Group.

The primary reason for the convergence of traditional opportunity funds in the market is that many firms are at the end or are coming to the end of the investment period for their current opportunity funds, which typically have a 2007, 2008 or 2009 vintage. Despite the boys being back in town, it is unlikely that these firms will be living it up this time around.

Last time out, these firms raised more than $8.3 billion of equity. As a rough benchmark, PERE recorded $3.2 billion of equity committed to higher-return funds in the whole of 2011 – less than half the amount these firms raised. Not surprisingly, therefore, some market participants anticipate firms will be more realistic about the size of their funds given that institutional investors are saying they don’t want fund managers to be sitting on uninvested capital given the uncertainty in the region. In addition, given the lack of financing available, it will be harder to put sizeable money to work, which is another reason why funds might not be as big.

Given the challenges, some people are going as far as to wonder privately which firms are going to make it at all. Will any become part of the consolidation story? It is a provocative question, and certainly not one to hazard a guess at here. That can be left to market professionals to speculate over privately, which they already are doing.

However, there are several issues and forces at work to ponder. Some funds are coming up to that magic 75 percent threshold of capital being committed, at which point the fund manager would begin to raise the next fund. However, some may not have called down the capital yet, perhaps because they are involved in a time-consuming development deal, giving limited partners grounds to rebuke them. Firms that can actually show called capital and deals to underwrite may be in a stronger position.

Some firms have ‘sugar daddies’, in that they either have large public firms behind them or recently secured private backing from large international platforms willing and able to fund the business. One could argue those firms also are in a safer position.

For those not blessed by a significant new injection of corporate capital, however, the first challenge is getting existing investors on board. There are a great variety of investors among these firms’ funds, but interestingly some of them are backed by US endowments and foundations. While as a group these investors are back in the market making commitments, they may not re-up with all the same funds again and may not write out cheques for the same amount as before. In addition, they may be looking at new geographies and strategies in which to invest, such as debt funds.

Another aspect to consider is that those firms that made investments via prior funds may not be showing any promote or return of capital yet. If the promote is not coming through, it makes life tougher when it comes to having sufficient internal resources to put up co-invest capital that investors will want to see in the next fundraise. That said, you could argue that investors may want to examine a fund manager’s balance sheet to work out how much will be enough for ‘hurt money’. It may be a smaller sum than previously required.

Yet another factor to consider is that many multi-managers were just embarking on their international programmes last time round, so they were cash rich. Now, many have mature portfolios and the industry is growing more slowly. Therefore, they will have less capital to commit until equity starts to be returned.

There is another factor still: the X factor. Accepting that investors will look at returns, signs of style drift, skill sets, risk management and everything else, some firms will come to the table with an investment story for their next fund that might just distinguish them from the competition. These are the nuances that could be important when it comes to success.

As I (hopefully) bask in the sun this month at the MIPM show in Cannes, I am reminded of when I attended the event during the boom days and limited partners were falling over each other to commit funds. A principal of a firm mentioned here shouted out to a friendly rival who I was meeting on a moored boat: “Forget it, you can’t afford him!” It seemed a little cocky at the time…