FEATURE: Kissing frogs

Two-and-a-half years ago, Bill Thompson was one of four senior members to leave Credit Suisse's real estate private fund group to launch a new real estate advisory business at New York-based investment bank Greenhill & Co. That business, which began with 12 professionals in New York, London and San Francisco, has grown to become one of the largest in the industry, with 19 advisors spanning multiple locations across the globe.

Over that time period, “the biggest change has probably been to our sleep patterns,” jokes Thompson. Speaking from his office in San Francisco, he describes to PERE a typical day at the firm, which can involve getting on the phone with European-based fund managers and London-based colleagues in the morning, a call with a US-based institution during the day and a conference call with a colleague in Sydney in the evening.

“At any point in time during the day, there's somebody on our team who's awake and conducting commerce,” adds his colleague, managing director Walter Stackler, from his office some 4,600 kilometres away in New York.

“We can't even figure out a good time to have a group call, where everybody can participate without keeping somebody up late or getting somebody up early,” quips Thompson.

Driving this change is the globalisation of capital flows. “That's changed the whole dynamic of this business,” Thompson says. “You've got to be global, and you've got to make the commitment to be global in order to be successful.”

Indeed, real estate capital flows have shifted significantly since the mid-2000s, when US public pension plans were the dominant investors in private equity real estate. Now, after suffering losses on real estate investments made prior to the global financial crisis, US pensions are putting out less capital, while Asian investors, which weren't in the market in the mid-2000s, have become much more active.

Whole new world

A more geographically diverse investor base, however, is just the start of how dramatically the world has changed for placement agents. Raising equity for fund managers – the bread and butter of the private placement business – has greatly diminished, despite there being 562 private real estate funds in the market globally this year, up from 505 in 2011, according to a September report from The Townsend Group.

Real estate GPs that launched funds in 2012 and are tracked by Townsend currently are seeking an aggregate of $90 billion in equity commitments globally, but they had only raised about $6 billion at the time of the report. Aside from there being a “glut of funds” in the market, LPs also continue to be cautious with how they invest their capital, the firm wrote.

“There are more GP choices than investors need to get exposure to different markets,” says David Sherman, president of Metropolitan Real Estate Equity Management, a New York-based real estate fund of funds manager. He notes, however, that the number of visits from GPs represented by placement agents have been down dramatically.

“Fund managers used to come in with placement agents several times a week,” Sherman adds. “It's a much rarer occurrence now.”

Much of this has to do with pure economics. Placement agents typically are compensated only if they successfully raise capital for their clients and, because each fundraising requires significant amounts of time and resources, agents often are highly selective in choosing their clients.

“They're as tough in screening general partners as anybody,” says Sherman. “They really need to be careful to take on business that is highly likely to be achievable.” Hence, the need for placement agents to “kiss a lot of frogs,” as some players have put it.

“There's more opportunity to raise capital for more groups,” says Lori Campana, managing director at Monument Group, a Boston- and London-based placement agent whose clients include Patron Capital, which closed on more than €880 million for Patron Capital LP IV – the largest European real estate opportunity fund raised so far this year. “However, you need to back up and ask how many of those groups should be getting capital from the institutional marketplace.”

Greenhill's Stackler agrees that there's a more rigorous due diligence process in selecting funds than ever before. “We are meeting with more managers than ever,” he says, noting that his group currently meets with close to 200 managers each year to find just six to eight new mandates, compared with about 125 managers in the mid-2000s. Greenhill's responsibility is “to identify the ones that will be well received by LPs and screen out the ones that aren't exceptional or won't get off the runway at all.”

Once a placement agent does decide take on a fund, the process of wooing an investor also has become much more lengthy and involved. “You have to do a lot more to get from dating to saying 'I do',” says Campana. “It used to be two meetings, but now it's four meetings, and it's 14 more questions, not five more questions, that need to be answered.”

The need to diversify

Of course, commingled funds are no longer the only investment option on the table. As investors have been seeking more control of their investments by allocating greater portions of capital to programmatic joint ventures, separate accounts and direct deals, placement agents have had to diversify the services they offer.

Park Madison Partners, for example, has broadened its business to include capital-raising for firms on a deal-by-deal basis. The firm, which has worked with clients such as Chicago-based Waterton Associates and Dallas-based TriGate Capital, expects to continue working on an average of three funds per year. It currently is raising capital for a US value-added real estate fund and is about to launch a new Latin American-focused vehicle.

However, “going forward, we'll be doing some other types of transactions, such as co-investments or programmatic joint ventures,” says Nancy Lashine, a managing partner at the New York-based firm. “Those deals tend to be smaller and quicker to execute.”

With this new focus in mind, Park Madison hired Gentry Hoit, an acquisitions professional who has sourced and executed transactions for firms such as Shorenstein Properties and Rubenstein Partners, as a partner in September. With the addition of Hoit, the firm expects to help newer real estate operators get access to capital for transactions.

“We'll help them try to find a capital partner or several capital partners to build their portfolio, where the deals are identified and the investor either has some discretion or is working on a deal-by-deal basis with them so that [the GP] can build a track record,” Lashine adds.

Park Madison, which currently has a team of seven professionals, also plans to add an additional marketing person over the next couple of quarters to assist with the expansion of services at the firm.

A similar shift is in effect at Greenhill's real estate capital advisory group. Prior to the global financial crisis, the team had focused 100 percent of its business on commingled funds. These days, the group also is raising capital for individual transactions, club deals, programmatic joint ventures and co-investments, as well as helping to execute trades on the secondary market and providing other advisory services.

“In this market, you've got to be flexible because capital has changed direction and you can't be just one thing,” says Thompson. “It's responding to LP needs. We are in the business of understanding what LPs are doing, and they're doing a lot of things right now. Therefore, to just keep showing them funds doesn't make sense. 

Fee squeeze

Although firms such as Park Madison, Hodes Weill & Associates and Triton Pacific Capital have been beefing up their teams in the past year, that doesn't provide a full picture of the placement agent industry. “A number of folks are struggling out there in this environment,” says one placement agent who spoke under condition of anonymity. 

When it comes to collecting fees on capital raised for funds, placement agents are getting squeezed on multiple fronts. During the mid-2000s, firms made most of their money off of first-time funds. Because most first-time fund managers didn't have relationships with investors, agents would earn fees on all of the capital raised.

First-time funds, however, have become much more difficult to raise in the current environment, so firms have been working more with existing managers, including those that previously had not used placement agents on fundraisings. Indeed, first-time funds accounted for about 60 percent of offerings during the mid-2000s; today, they represent only about 30 percent, according to Greenhill's Stackler. 

Working with follow-on managers, however, typically means lower revenues for placement agents, as capital raised from existing investors often is “carved out” of the fee that an agent would earn on a fundraising. In addition, managers typically have used carried interest from funds to pay placement agent fees for future capital raises, but the poor performances of some recent vintage year funds have affected the ability of some managers to pay those fees.

Meanwhile, competition among placement agents has further compressed fees, which have declined by an average of 100 basis points from the typical 3 percent fee agents had collected for first-time fundraisings during the height of the market. “Two or three [firms] can command fees and choose who they want to work with, then there are the others who will work with the rest and take whatever [fee] they can negotiate,” says one former placement agent. Still, “even top-tier firms have seen fees compressed.”

Banned in multiple states

Another significant carve-out of fees has come from bans that have been instituted in several states, which prohibit or restrict placement agent involvement in investments made by pension plans. Many of these bans were put in place over the last couple of years in the wake of high-profile pay-to-play scandals at two of the largest US pension systems. 

Last year, former New York state comptroller Alan Hevesi was sentenced to one to four years in prison for his role in a corruption scheme, where he approved $250 million in investments by the New York State Common Retirement Fund in a private equity fund called Markstone Capital Partners. In exchange, Hevesi received nearly $1 million in overseas travel, campaign contributions and other benefits. 

This April, the US Securities and Exchange Commission charged Fred Buenrostro, the former chief executive officer of the California Public Employees' Retirement System (CalPERS), and Alfred Villalobos, a former member of the CalPERS board, with several counts of fraud relating to the alleged fabrication and misuse of disclosure letters sent to private equity firm Apollo Global Management to secure millions of dollars in placement agent fees for Villalobos and his placement firm ARVCO. 

“What really has hurt the business is the ban on placement agents,” adds the former placement agent. In some cases, placement agents can work with a state pension plan as they normally would, but they would not be able to earn a fee on any of the capital raised from that pension. In other cases, agents are barred from interacting directly with a pension plan, although they still would perform much of the background work on the fund, such as due diligence or writing of the private placement memorandum.

As these restrictions have stemmed the deal flow for the private placement businesses, some firms are considering reworking their business model. “It's probably going to change how agents are going to do business with some groups,” says one placement agent. Instead of firms earning fees based on the amount of capital raised for a fund, “it may be more advisory assignments, where you're getting paid for a broad-based advisory service that doesn't relate to the individual ticket that is written within an individual fund.”

The great divide

The placement agent ban highlights a critical issue in the industry: the divide between small- to mid-sized investment managers, which typically use third-party placement agents to help raise institutional capital, and larger firms, which often have the scale and wherewithal to hire their own in-house capital-raising teams.

“I believe the placement agents play an important role by helping small and medium-sized funds access capital,” says Nicholas Bienstock, managing director at Savanna, a New York-based real estate investment firm that has raised capital through funds.

In a letter included in a 2009 report on placement agents by the California State Teachers' Retirement System, Bienstock described how Savanna had hired Park Hill Real Estate Group to help the firm restructure its business from investing on a deal-by-deal basis to raising capital through a private equity fund structure. “Could we, as a small investment firm, have managed this process and transitioned to an institutional fund structure without a capable placement agent?” he wrote in the memorandum. “Absolutely not.” Savanna has since worked with Park Hill on two subsequent institutional fundraisings.

The restrictions by pension plans have made it more difficult for agents and their clients to do business by limiting access to those pensions where bans are in effect, Bienstock tells PERE. “The placement agent ban, while sounding politically attractive, negatively impacts the pension investment process and ultimately steers capital to the small handful of large funds who are unaffected by the ban at the expense of smaller businesses,” he says. The placement agent ban, therefore, has benefited larger fund managers by reducing competition, he contends.

Larger fund managers, however, view the role of placement agents in another way. “The internal and external placement models are different – really apples and oranges,” says Hugh Macdonnell, head of the global capital markets group at Clarion Partners. “The best placement agents perform an incredibly valuable role for the industry by helping new, high-quality managers access strong investor networks and performing a vital screening and due diligence role for those investors.”

Placement agents, however, have a contractual relationship with managers, while “internal capital-raising and client management teams have a different role that is guided first and foremost by a long-term trust and partnership relationship between GPs and their LPs,” explains Macdonnell.

Currently, Clarion has a client services team of about 15 to maintain its relationships with more than 200 investors that represent more than $25 billion of assets under management. Since Macdonnell joined the firm last fall, the team has added professionals from TIAA-CREF, Aviva Investors and Aetos Capital to focus on clients on the West Coast of the US; Europe, the Middle East and Africa; and Asia, respectively.

The LP perspective

A handful of major US pension plans aside, many investors generally are supportive of placement agents and their role in the industry. By screening hundreds of fund offerings, “they often make the process more efficient,” says one LP who declined to be identified. “But all private placement agents are not created equal. The best ones, in my view, have a history of bringing good names to market, have a solid understanding of the investment thesis and offering, are responsive but not overbearing and know when to get out of the way and let investors speak and work directly with the GP.”

Ultimately, how well placement agents continue to fare rests largely in the hands of LPs. Because of the economic and political uncertainties relating to issues such as the US presidential election, the US fiscal cliff and the future of the Eurozone, “the investment market right now is about as illiquid as we've ever seen,” says Sherman. However, he expects some of those uncertainties to be resolved in the near term. “In the next six to 12 months, we'll have more visibility about the future.”