An already-difficult fundraising environment may become even more challenging, if recent US pension allocations are any indication.
US public pensions pulled back significantly on their real estate equity allocations during the second quarter, in what could be a sign of a larger slowdown, according to a report from FPL Consulting. Commitments to real estate managers have been declining since the fourth quarter of 2015, when total earmarks were reduced from $13.2 billion to $8.2 billion, before bouncing back to $11.8 billion in the first quarter of 2016, according to the Chicago-based advisory firm, which has tracked commitments since 2011.
Whether the decrease in allocations is a blip or the new normal, managers, particularly midsized ones, need to think about how they should potentially revamp their fundraising strategy in order to capture their slice of a shrinking pie. Fundraising among mid-market firms, after all, has been stagnant the last two years: managers with $200 million to $1 billion in assets under management raised $10.6 billion overall in 2013, $10.94 billion in 2014 and $10.97 billion last year, according to PERE research. The market is only getting more crowded, with two to three mid-market fund managers chasing each dollar of available investor capital, FPL says. With shrinking pension investments and more competition, mid-market managers need to move beyond Fundraising 101 lessons to differentiate themselves in their next rounds of capital raising.
Before embarking on the capital raising process, sponsors must understand the mindset of limited partners on real estate investing. One placement agent said that, across pension sizes, limited partners were much quicker to commit to all types of funds in 2013 and 2014, including first-time funds and those targeting new geographies, than they are now.
The placement agent recommended that capital raisers start conversations about their next fund early with existing investors and with those that came close to committing in the past. With many investors worried about market cycles, mid-market sponsors should point to past successes from a crisis-era fund to demonstrate how the firm overcame a challenging period. For both existing and potential investors, telling a compelling story to differentiate a firm and strategy as early as the first potential investor meeting is critical now more than ever. That story, whether it be highlighting ESG practices or proactively addressing succession planning, transparency and customer service-related topics, might not ultimately win a mandate, but it can help firms avoid the initial filter.
An executive at an advisory service firm noted that questions on compliance and other back-end issues are becoming more important and showing up earlier in the fundraising process, both in an investor’s initial checklist and as a topic of conversation by the third meeting. A year ago, he said many pensions might have given mid-market managers a break on having subpar transparency and infrastructure, but now, best practices from the top firms have raised the bar for managers of all sizes.
Fund managers should also be sure to nurture their LP relationships, spending time with investors to avoid being left out in the next round of allocations. One consultant said that he is still surprised when he hears of private equity real estate veterans behaving condescendingly toward investors – and in a relationship-driven world, those LPs will remember who treated them well, and tell other investors about those who did not.
Finally, firms having a tough time getting checks from US public pensions may consider looking elsewhere. In an August global management survey, FPL highlighted international investors and retail channels as increasing areas of focus for many managers.
To be sure, there is no silver bullet for fundraising. Even the best-articulated pitch likely will not save a firm with a poor track record, but emphasizing differentiation – and seeking it out in the next fund’s investor base – should help mid-market firms as investor dollars for funds potentially become more scarce.