Ten themes as 2009 turns to 2010

The year 2009 was one of restructuring, pain, change and rethinking. It was also a year of preparation,

Looking ahead

with limited and general partners preparing themselves not only for the next opportunity ahead but the next stage of evolution in the private equity real estate fund model, but the industry itself.

Here we pick the themes that dominated the agenda over the past 12 months. Some themes speak to the grimness of the situation we’ve come from (which some are still in); other takeaways bode well for what’s to come next year and beyond.  


1. The government gets involved

The credit crisis of late 2008 saw unprecedented levels of government support for the world’s financial systems and wider economies as the entire globe attempt to prevent a 21st Century Great Depression. And although real estate was never intended to be a direct beneficiary, it was directly affected. From the nationalisation of lenders, such as Hypo Real Estate in Germany (and the near-nationalisation of the Royal Bank of Scotland in the UK), to the introduction of numerous bailout programmes aimed at pumping billions of dollars of liquidity into the system, governments globally injected themselves into the real estate investment community. The question for 2010 will be how they extract themselves without creating a 2008-style systemic risk scenario.


2. Pray and delay

During the RTC crisis there was a favourite saying among real estate investors, “Stay alive ‘til ‘95”. Today that cliché has morphed into “extend and pretend”. One of the consequences of global governments’ massive bailout schemes has been to recapitalise banks and financial institutions, without requiring them to write-down their real estate assets. As a result, one of the major complaints heard in 2009 was the willingness of banks, particularly in the US, to extend loans with pending debt maturities, where the debt service was being met, even if valuations had reduced dramatically. “Extend and pretend”, or “pray and delay”, was a hope certificate being awarded by banks to borrowers in the belief that values could (eventually) rise. For many though, it is an exercise in merely putting off the inevitable.

3. Investment banks buy high, sell low

Real estate became a dirty word in the minds of many banking institutions in the immediate aftermath of September 2008 – a perception that had major implications for some bank-sponsored private equity real estate platforms in 2009. Citigroup and Merrill Lynch were two of the big names that decided to voluntarily exit the business, partially in the case of Merrill, which put up for sale the management of its Asia property funds. Selling people businesses though is never easy, and by December, Merrill had shelved its plans owing to improving market conditions in Asia. Citigroup’s sale of its five-year-old group, Citi Property Investors, is expected to be completed next summer, but as PERE said in September the bank’s decision only ensures it misses out on the potential for outsized returns in the future. Buying at the height and selling at the bottom really is cutting the nose off to spite the face.

4. Debt is the new equity

With little to almost no financing available to investors in 2009, global property transactions were minimal. However for many of those able to trade, real estate debt was the only strategy in town, particularly debt positions that gave investors the ability to take over the actual real estate. “Loan-to-own”, as it has been dubbed, has seen the foreclosure and transfer or landmark properties, such as Boston’s John Hancock Towers and New York’s W Union Square Hotel, after investors bought up whole loans, mezzanine and CMBS debt secured by over-leveraged assets. 2010 will no doubt continue to be year in which it’s all about the capital stack.

5. Where lies the bottom?

No-one can predict when any particular asset class or sector will ever hit bottom, but there were some real estate markets that hit the repricing pedal faster than most, namely London and some Asian, especially Chinese, cities. With aggressive write-downs and repricing, London was hailed as a global example of how to turn the corner of a real estate recession. However, with little product hitting the markets, investors have since started to warn of mini “bubbles” emerging for prime, quality assets.

6. Cloudy future for blind pools

LPs and GPs had a lot to talk about in 2009 when it comes to the blind pool, closed-ended private equity real estate fund. From fees, governance and alignment of interest the fund model has come under intense scrutiny by all sides. However, for some the actual fund model itself has also been a point of contention with many large institutional investors, including some sovereign wealth funds and US public pension plans, choosing to invest through separate accounts and club deals instead. Control has been a key sticking point. LPs feel the commingled fund model failed to protect their interests, preventing them from taking greater control of their investments when things went wrong. GPs argue discretion is vital if investors want more than core-like returns. The debate will run well into 2010 (if not beyond).

7. Regulation rollercoaster

Taxpayers became involved in the financial industry in ways that few could have imagined just a few years ago. Following massive public bailout schemes around the world, governments naturally demanded the price for such action – with additional regulation. Over the past year, the European Union continued to refine its controversial Directive on Alternative Investment Fund Managers, which is expected to cost billions in compliance costs, impact manager compensation and limit LP access to certain funds. Across the Atlantic, numerous pieces of legislation were proposed by US Congress members, including bills that would require SEC registration of private fund managers, give states power to regulate managers and increase tax on carried interest.


8. Asset management mania

If 2008 was the year when the party ended, then 2009 was the year when the cleaners were sent in to tidy up the mess. No GP, which had been active during the height of the market, was spared the pain of the credit crisis. With valuation declines of at least 30 percent in most global property markets, 2009 was a year focused on managing assets – and in some cases, fighting fires when they emerged. It was all about renegotiating with lenders, recapitalising legacy assets, and – in some cases – even funds. For some that meant asking LPs for additional equity or for permission to draw down commitments for existing assets, for others it meant seeking rescue capital (such as preferred equity or mezzanine capital) from third parties or handing back the keys. As one GP told PERE early in 2009, it was time to “kiss your bricks”.

9. Back to basics

To say that real estate investors lost sight of fundamentals during the height of the market is perhaps the understatement of 2009. The age-old principle of real estate being an income-producing investment and a hedge against inflation was largely forgotten as capital gains drove investment decisions from Houston to Hyderabad. However, as investors look to 2010 real estate has come back to its core values, in that cash flow is king. Even given the lack of transactions taking place globally, there were repeated stories of (small) bidding wars taking place for solid, quality assets with existing cash flows in place. Real estate, as many veterans have proclaimed, is back to basics. That is, until the next bubble emerges.

10. Sitting on the sidelines

If there is one major difference between the crisis facing real estate investors today compared to the RTC, it’s that a lot of investors have cash ready to deploy now. Whereas in the 1990s, it took real estate investment managers several years to get their capital together, today many already have their wallets open preparing to pounce. Few are able to quantify the volume of cash sitting on the sidelines, although estimates are often in the $100s of billions range. After years of overpaying for and over-leveraging assets, commercial real estate will be the next shoe to drop, these investors argue – and they want a piece of the action. And its not just the established names that are waiting. New faces from the hedge fund and private equity world are entering the asset class in the expectation of opportunities to come. As the industry, globally, widely expects: 2010 could herald the real estate opportunity of a lifetime.