Almost everyone can agree that being a private equity real estate fund manager is lucrative. Once you achieve meaningful assets under management, the benefits of economies of scale really supercharges the commerce of being a manager. Over the years such large managers have come to dominate the real estate landscape.
It is prescient at this time to note that many of the funds managed by the global behemoths also suffered significant losses during the global financial crisis of 2008. The GFC seems like a lifetime ago, but the mistakes made in the heady days prior to the GFC are not fully behind the real estate investment community. If one were to scour the real estate press following the GFC, it could be concluded that the fund model was dead, so frequent and definitive were the obituaries.
As it turns out, the commingled fund model remains alive and well, but deeply flawed. Often governance is non-existent and investors are cornered into decisions they don’t agree with. Many fund managers are not real estate or sector specialists, with most relying on local operating partners without appropriate alignment. Also, funds are frequently forced to exit at the wrong time in the cycle. In spite of these shortcomings, the fund model continues to exist and is not expected to go away anytime soon. That is just as well, since a whole plethora of institutional investors seeking global exposure do not have the local teams or skill set to deep dive into markets to find the best operating partners to execute a particular strategy.
However, other investors, like APG, are equipped with the scale to invest with local partners rather than through commingled funds. I will be the first to acknowledge that we had our fair share of problems during the GFC. We lost value in some of our holdings and learned crucial lessons at the time. Those lessons are now ingrained in us and drive our strategy to a large extent. Firstly, without alignment with a strong local operating partner, our investments are unlikely to outperform across cycles. Secondly, having control over the assets we buy is a right we actively seek, especially in new markets and sectors. Finally, in many cases external managers do reasonably well given the substantial fees they receive, irrespective of investment performance.
Post-GFC, we have made a conscious effort to put these insights into practice – to team up with best-in-class local operators and in many instances to acquire meaningful stakes in these management platforms – Chongbang (retail) and ESR (logistics) in China, Lemon Tree (hotels) in India, Scape (student accommodation) in Australia, just to name a few. It is a unique way of investing and a structure that has already reaped substantial rewards for us – be that in the form of scale, greater transparency and influence through our board positions in these companies, or sharing in the valuation upside of the management platform – all of which enhance alignment.
To be clear, there are challenges with this model too, most pressing being the need to distinguish between our role as a board member and our desire to protect our minority position, but nothing compared to the inherent difficulties of a fund investment. Also, long term investment performance remains to be proven, although early signs are positive.
As an institutional investor, we take long term views as we set up, expand and institutionalize the management platforms we invest in, without necessarily feeling the pressure to exit at the wrong time. By the same token, we do not take our position of privilege for granted. We bring significant value to our partners through our involvement in the strategic management of these companies, crossover of best practices from our global investments, mentorship to the management team and most importantly, helping them raise growth capital by leveraging our reputation and relationships with our peers.
You will see us doing more of these types of investments in the time to come. The fund model certainly continues to thrive, and we may still selectively invest in funds, but for APG, the constraints of the fund model are all too obvious and we believe we have found a better way to expand our global real estate portfolio.
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