STATESIDE: Billion-dollar babies

In the fight for investor capital, the heavyweight category appears to be getting a little crowded. The latest contender to enter the ring is Dallas-based Lone Star Funds, which just started pre-marketing its newest property fund, Lone Star Real Estate Fund (LSREF) III. With a hard cap of $6 billion, it also is the largest real estate vehicle currently in the market. 

Lone Star will have a fair amount of competition in the $1 billion-plus category. Just one week prior to PERE breaking the news on Lone Star’s massive fund in mid-June, the Wall Street Journal revealed that The Carlyle Group was planning to launch its seventh US real estate fund, with a goal of as much as $4 billion. 

That news was preceded by media coverage in February on Morgan Stanley Real Estate Investing readying a new global opportunistic real estate vehicle, seeking up to $3 billion in capital. And, at the start of the year, Kohlberg Kravis Roberts & Co was reported to be pursuing its first dedicated real estate fund, which PERE has since learned is targeting $1 billion in commitments.

To be sure, raising a ‘billion-dollar baby’ post-global financial crisis isn’t exactly novel. After all, The Blackstone Group last year closed on $13.3 billion for Blackstone Real Estate Partners VII –the largest property fund ever to be raised – at a time when the fundraising market was far from robust. With that record fundraise under its belt, Blackstone is back raising a new real estate vehicle, seeking $3.5 billion in commitments for its first Asia-focused fund.

PERE certainly isn’t suggesting that we’re on the way to returning to the boom-boom fundraising years of the mid-2000s. Still, this year’s batch of billion-dollar babies is notable, both in terms of the number and size of these funds. According to PERE Research & Analytics, there currently are 28 real estate equity funds targeting $1 billion or more, up 33 percent from June 2012 and June 2011, when there were just 21 such funds in market both years. Of those 28 funds, eight are seeking $2 billion or more, compared with four in June 2012 and six in June 2011. 

Of course, some fund sponsors, such as Lone Star and Morgan Stanley, are returning to the market simply because they have deployed nearly all of the capital in their current real estate funds. At the same time, some of these firms are targeting capital raises that would rival those during the peak years of the market. 

For example, Carlyle’s new offering, if successful, would be the firm’s largest – $1 billion more than its current largest vehicle, the $3 billion Carlyle Realty Partners V, a vintage 2006 fund. And while the target for LSREF III is less than the $10 billion Lone Star originally had hoped to raise for its predecessor (for which it ultimately raised $5.5 billion), the new fund likewise would become the firm’s largest in commercial real estate if it achieves its $6 billion target.

Such supersized funds – and the greater number of them – are signs of greater optimism among fund sponsors about investor demand for commercial real estate. Indeed, “aided by low interest rates and a lack of alternative investment options that offer comparable risk-adjusted returns, the desire to own commercial real estate remains strong among both domestic and international investors, despite a drawn-out recovery,” according to this year’s PwC Real Estate Investor Survey.

That demand, moreover, is focused on value-added and opportunistic strategies, which account for 22 of the 28 $1 billion-plus funds tracked by PERE Research & Analytics. As yields have compressed considerably in core real estate, investors are showing a greater appetite for risk than they had just a couple of years ago. The lack of risk appetite was one of the reasons why it was nearly impossible to raise opportunistic funds from 2008 to 2010. With this bigger investor shift to higher-return strategies, more managers have been putting their fundraising gloves back on.

Nonetheless, most firms still will need to put up a fight. “It’s still ferociously competitive out there and, in a competitive environment, there will be winners and losers,” said one industry insider. PERE’s view is there will be more losers than winners because, despite the stronger investor appetite, there nonetheless isn’t adequate demand to make all of these billion-dollar babies a success. 

One of the deciding factors in whether a fund will become a heavyweight champion is the track record of its sponsor. Strong returns in prior funds, as well as a well-established real estate platform, will help to stack the odds in a fund manager’s favor. However, to deliver a one-two punch in fundraising, a sponsor also will need to show realizations. After all, investors understandably want their capital will be returned to them quickly. Moreover, in the case of certain limited partners, most of their money is locked up in existing investments, so they only will be able to make new commitments to funds if they get their capital back.

It’ll be interesting to see which billion-dollar babies will emerge victorious from this latest round of fundraising battles. Place your wagers now.