At the PERE Global Investor Forum in Los Angeles in April, a speaker made the following remarks: “It's been a successful marketing campaign and a lot of investors have gravitated towards that.”
Moments before, however, he referenced the same campaign as a “gimmick,” in the eyes of some in the industry. He was talking about core-plus real estate.
Although the term “marketing campaign” would appear to indicate otherwise, core-plus is not a new strategy in private equity real estate. Open-ended core-plus funds have been in existence since the early 1990s, according to the National Council of Real Estate Investment Fiduciaries. On the closed-end side, Angelo Gordon launched its core-plus series of funds, Angelo Gordon Core Plus Realty Funds, more than a decade ago.
But, the strategy has attracted a wave of new capital in recent years as historically opportunistic real estate firms have broken into the space, particularly The Blackstone Group, which officially launched its core-plus business in 2014 and had raised nearly $11 billion for the platform as of March 31, according to the firm's first-quarter earnings results. Other large managers have followed suit, notably The Carlyle Group, which announced the launch of its core-plus fund on an earnings call last year, and Brookfield Asset Management, which is understood to be in the process of rolling out its own core-plus offering.
Core-plus funds sponsored by opportunistic firms are viewed as a different breed than those sponsored by what some call the 'sleepy core guys.'
“The current generation of core-plus is a bit more targeted,” says Christopher Rice-Shepherd, managing director at alternatives advisory firm Cliffwater. “They're more strategic in terms of the property sectors and geographies in which they will invest, and that makes them stand apart from the traditional open-ended funds, where portfolio composition does not significantly differ from the major indices.”
Explaining the appeal of opportunistic managers investing in core-plus, Alison Garcia, director of real estate at the North Carolina Department of State Treasurer, says: “It's just their overall approach to value creation. It's using the same thought processes and strategies to add value in the core space that they do in the opportunistic space.”
Blackstone, for example, which has been known for executing large, complex deals in opportunistic real estate, has been applying the same strategy to core-plus. Transactions in the latter strategy have included last December's $5.3 billion acquisition of Peter Cooper Village Stuyvesant Town – which involved a public-private partnership and tax complications – or the privatization of Excel Trust for $2 billion last year.
“We generate the plus by focusing on the largest, most complex situations, where high quality underlying assets and markets give us an opportunity to drive value over long periods of time,” says Frank Cohen, global head of core-plus real estate at Blackstone.
Meanwhile, Carlyle is understood to have made niche strategies a major focus of its core-plus fund, similar to its opportunistic fund strategy. The firm is seeking to invest up to 45 percent of the capital in Carlyle Property Investors in senior housing, medical office and storage properties, according to a March document from the Burlington Employees' Retirement System.
“I suspect core-plus may be an even larger market than opportunistic in the end because there are more products you can buy with a core-plus type of return,” said Carlyle co-chief executive David Rubenstein in an earnings call last October.
For the love of core-plus
In many cases, the entry of opportunistic private equity real estate firms into core-plus real estate has been at the behest of investors, many of which have shifted to lower risk, lower return strategies following the global financial crisis.
“They were strong key relationships of ours and we asked them to get into the space,” says Garcia. North Carolina Retirement Systems – which has committed a total of more than $2 billion to the core-plus strategies of firms such as Blackstone, Rockpoint Group and Rockwood Capital – first began investing in core-plus in 2010, as the pension system was re-examining its property portfolio in the wake of the global financial crisis. “We felt one of the gaps in our portfolio was that we didn't have a strong enough focus on current income,” she recalls. “We wanted strong durable current income. Even back then though, core pricing felt pretty rich.”
At the same time, very little capital was being allocated to core-plus, which the pension system saw as a way to buy quality assets at better pricing. “It seemed attractive from a risk-return perspective,” she says.
The strategy also has been endorsed by numerous consultants. “We favor core-plus strategies relative to value-add and opportunistic at the current stage of the market cycle,” says Rice-Shepherd. Although value-add and opportunistic funds of the last five vintage years have outperformed, 2016 and 2017 vintage funds are expected to generate lower returns because of the higher pricing in the market. By contrast, core-plus funds may be more defensive as a result of shorter-duration business plans, which many find preferable in an uncertain real estate market.
Core-plus also appears more attractive relative to core, adds Jarrod Rapalje, senior consultant at Courtland Partners. “If a manager is trying to get to 9 percent to 11 percent net return, and half of is that from current income, that resonates with a lot of investors when the alternative is to buy into a fully-priced core open-end fund at sub-5 cap rates. If they're thinking about how they're allocating their core dollars, it's sold pretty well.”
No bright lines
Core-plus, however, has been as difficult to define as it has been popular. “What is truly core-plus?” asks Rapalje. “That means something different to everyone.”
Generally speaking, core-plus falls between core and value-add on the risk and return spectrum. Core-plus typically involves 9 percent to 11 percent target net returns and 50 percent leverage, compared with 7 percent to 8 percent net returns and 22 percent leverage for core and at least 12 percent net returns and 60 percent to 65 percent leverage for value-add. Core-plus is generally accepted to mean real estate properties that have high occupancy levels and are generating cash flows. But within that broad definition, there are many differences of opinion.
“I don't think there's a bright-line test,” remarks Garcia. “I think that's what makes real estate unique. It doesn't fit well in these little boxes.”
For example, some core-plus strategies call for the majority of the portfolio to be invested in stabilized core assets, with a small allocation to development to achieve the 'plus.' However, to Garcia, “speculative development generally is not a core-plus activity, or only minimal amounts in certain low-risk circumstances.”
The industry also diverges over what geographic markets are included under core-plus. Rockpoint is said to limit its investments to core, high-quality properties in gateway markets. And Blackstone also is understood to have a bias toward gateway markets, but also can invest in non-gateway markets for certain types of real estate assets, such as grocery-anchored retail.
Rice-Shepherd takes a broader view. “I don't think of core plus in geographic terms,” he says. “It's really about the business plan. Location is important but in this last cycle, as we've seen the gentrification and urbanization of non-gateway markets, being in secondary or tertiary markets does not disqualify an asset from being core-plus.”
In some ways, it is easier for industry professionals to define core-plus not by what it is than what it is not. Rice-Shepherd rattles off a few examples: “If it's not cash-flowing from day one, it's not core-plus. If the business plan requires any time where there is income interruption, that's not core-plus. If it takes more than 24 months to 36 months to reach stabilization, it is not core plus. If it's a four-to-five-year lease up, it's not core-plus – you could be in a different market by then.”
The core-plus label has stirred up confusion in other ways, as some have equated the strategy with “levered core.” Rockpoint, for example, launched its first core-plus fund, Rockpoint Core-Plus Fund, in 2013, closing on a total of approximately $1 billion a year later. However, the firm subsequently changed the name of the fund series to Rockpoint Growth and Income Funds.
Consultants and investors were said to have told the firm that they typically associated core-plus funds with buying core assets and achieving the 'plus' through higher leverage. PERE understands the name change was intended to better reflect the fund's focus on generating returns through active asset management.
“People execute it differently,” says Garcia. “Some may be buying core and just putting on additional leverage. But if done correctly, in the true spirit, it's very different.”
Meanwhile, some take a cynical view on opportunistic firms' expansion into core-plus. “There are definitely managers driven by AUM [assets under management] accumulation – the public companies, for sure,” says one real estate manager. “That's just how they're valued.”
Agrees one consultant: “It's totally an AUM builder. It's a money grab. There's nothing wrong with it, but they're taking advantage of the market opportunity.”
The consultant takes particular issue with the fact that the expected fee load increases significantly from an average of 100 basis points for traditional core funds, to an average of 200 basis points for core-plus funds. “It's one thing with a high returning opportunistic vehicle,” he says. “But in a core-plus fund, you don't expect the return to be that high. You're giving away a lot of upside at not really high returns.”
The fee schedule for Blackstone Property Partners and Carlyle Property Investors, for example, calls for 10 percent carry and a 7 percent hurdle rate with a 50-50 catch-up, while the fees of Rockpoint Growth and Income Real Estate Fund II include a 15 percent carry over a 7 percent preferred return with a 30 percent catch-up, according to investor documents and market sources.
Garcia, however, says she does not have a problem with paying for performance in the core-plus space. “I would much rather see managers getting a performance fee if they're adding value, and if they are focused on value creation, rather than buy-and-hold,” she says.
Despite the large amounts of capital that have been raised for core-plus, Garcia notes that much of the money in the space is fairly new. “It's still a drop in the bucket compared to the core or opportunistic universe,” she says.
Indeed, during an earnings call in April, Carlyle co-chief executive Bill Conway estimated that core-plus accounted for “maybe” 1 percent or 2 percent of real estate globally, compared with 95 percent to 96 percent for core and 2 percent to 3 percent for opportunistic.
Yet, many expect core-plus real estate numbers to multiply.
As Rapalje says: “It continues to grow exponentially. I don't see any reason it doesn't continue to get traction with clients.
It makes a portfolio more interesting and more diversified.
Now you've got exposure to a manager that you like on the opportunistic side that you think is going to outperform and bring in some interesting deal flow that hopefully is complementary to existing core. And you're always looking for products that are complementary to what's in the existing portfolio.”