Though the first half of 2018 showed a strong start for real estate debt fundraising, the total capital raised for the year represented a stark drop from the $39.08 billion raised for the strategy in 2017, according to new PERE data.
During the last 12 months, real estate investment managers closed on $20.39 billion for real estate debt-specific funds, plunging 48 percent from the year prior, the data showed. In fact, the fundraising volume for real estate is at its lowest levels since 2011, when vehicles targeting the strategy raised $8.18 billion.
Real estate debt fundraising brought in $15.66 billion from investors in the first half of 2018, but by the second half of the year, capital raising had slowed to a trickle, adding just over $5 billion in six months.
Such a significant drop after four years of year-on-year fundraising increases is likely driven by multiple factors, including the strategy’s “nichey” status and small market size, according to Kelly DePonte, managing director at placement agent Probitas Partners.
Real estate debt funds emerged as an alternative financing source after the global financial crisis when banks limited their lending. Compared with private equity real estate funds, the market for private real estate debt is still small and relatively new to investors, which means a few large funds can skew the numbers, DePonte told PERE.
He noted that Goldman Sachs’ $6.7 billion Broad Street Real Estate Credit III fund and AllianceBernstein’s $3.1 billion AB Commercial Real Estate Debt Fund III both closed during the first half of 2018 and likely drove the high fundraising total. No other real estate debt funds held closes comparable in size to those in the second half of the year.
As a niche strategy, real estate debt likely also faces more limited demand from investors, DePonte added. “Many LPs only make commitments to very few funds as their core investments in that niche – once they are satisfied, they are often more focused on re-ups than backing new managers.”
It is likely that many investors have now reached their portfolio allocation limits for real estate debt, DePonte said. Others may have pulled back in 2018, fearing that real estate debt would not perform well in the next stage of the cycle.
Additionally, real estate debt funds have been affected by diminished demand for financing, said Henri Vuong, director of research and market information at the European Association for Investors in Non-listed Real Estate Vehicles. At this point, there is plenty of equity in the market, which lessens the need for debt, she said. And as real estate debt funds face the challenge of deploying capital, it makes less sense to raise another fund until the capital is deployed.
“You need to account that real estate is quite a slow-moving asset class,” Vuong said. Thus, record levels raised for real estate debt funds the previous year may not set up the next year for another capital raising record for the investment strategy.
Looking into 2019, Vuong anticipates a more cautious approach from investors as the real estate cycle extends past its predicted 10-year life. She expects fundraising across different investment strategies to grow less quickly than it has in the past five years.
To be sure, 2018’s drop in real estate debt fundraising may be the outlier rather than an indicator that fundraising will continue to slow in the future. Anecdotally, Keith Largay, managing director on JLL’s capital markets team, has seen increasing amounts of capital flowing into the real estate debt space while competition to deploy capital ramps up.
JLL’s own data illustrated a fundraising decrease from 2017 to 2018. But Largay attributed the decline to a number of large funds that likely closed in succession during 2017, making 2018 volumes look small in comparison. Unlike Vuong, he believes fundraising in the real estate debt space will ramp up again in 2019 and 2020 as larger funds launched in prior years finish deploying capital.