Private real estate’s squeezed middle is finding room to grow

For years, the consolidation of the private real estate funds industry has benefitted a select few: the very biggest managers, which have been able to raise repeatedly larger funds.

Some have described the evolution as creating a ‘barbell’ within the space and a ‘squeezed middle’ tier of managers and funds. With an abundance of capital flowing to a handful of large managers on one end and a plethora of small specialists on the other, the mid-size market was left lean.

PERE’s 2021 Q3 fundraising numbers are painting a notably different picture. More than $51 billion was closed last quarter, according to PERE’s Q3 2021 Fundraising Report, published yesterday, making it the biggest third quarter for real estate fundraising in recent memory and one of the best three-month stretches for capital formation ever.

The main takeaway: this feat was accomplished without a single mega-fund, which PERE defines as a closed-end vehicle containing at least $5 billion of equity.

Such funds have had an outsized influence on fundraising volumes in recent years. Since 2015, they have accounted for an average of $27 billion equity annually. In 2019 alone, four mega-funds closed on a combined $49.7 billion.

The surge in fundraising seen in Q3 2021 was driven by mid-size funds: those that are large but not quite mega. Last quarter, 16 funds closed between $1.2 billion and $4.3 billion, accounting for $34.8 billion of equity. Within the next strata of funds: those with $500 million or more but less than $1 billion, another 16 funds closed on $10.8 billion. The remaining $6 billion or so came from various smaller vehicles.

At the midway point, 2021 was on pace for the lowest fundraising volume in a decade, with less than $62 billion closed. But even then, the industry secured more capital with fewer vehicles. The average closed fund size was $577 million, which would have been a record high had it carried through to the end of the year. Through the third quarter, the sector is now averaging $599 million per fund.

Why have mid-size funds suddenly come into vogue? A few patterns have emerged. The first is the shrinking number of fund closings, which has been ongoing since 2017’s peak of 532. Through three quarters, only 193 funds have closed in 2021, putting it on track for the fewest closing since the global financial crisis. The implication here is, even as mega fund closes have been absent, fewer small vehicles are finding support. The middle-tier is where the action has happened.

Another trend is the success of groups focused on in-demand property types. Of the 16 funds to close on $1 billion or more last quarter, seven were sector-specific vehicles focused on industrial, residential or tech-focused alternative real estate. That includes four of the top seven closing, totaling $9.4 billion. A similar trend played out during the first half of the year, too. Investor preferences have been shifting toward what have been termed ‘beds, sheds and bytes,’ particularly during the pandemic. Groups that specialize in those spaces are reaping the benefits of that demand.

Mega-funds are not going away. In fact, shortly after the third quarter came to an end, Starwood Capital announced the closing of its 12th global diversified opportunity fund on $10 billion. Likewise, the Carlyle Group, which has already surpassed the $6 billion target set for its ninth flagship opportunity fund, is expected to hold a final close soon. At least three other funds are in the market seeking $5 billion or more, including Blackstone, which said on an earnings call late last week its third Asia opportunity fund, Blackstone Real Estate Partners Asia III, had collected $4 billion toward an approximately $9 billion target.

Still, the fact that 2021 has kept pace with fundraising volumes without mega-funds factoring into the equation is a noteworthy shift. While the total number of funds continues to fall, more than just a handful of firms can benefit from a consolidated market. The squeezed mid-market has, for the first time in years, found a little more room to grow.