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Why a pipeline is no longer a selling point

A seed portfolio, ‘essential’ to attracting capital prior to the covid-19 pandemic, has become a liability for many firms in fundraising mode.

For many managers, having pre-identified assets in a fund had been one of the major selling points to investors before the outbreak of covid-19. But today, a pipeline is often a liability for firms in fundraising mode.

“Nearly every consultant and every institutional investor was telling the GP community, ‘I want to see a seeded portfolio, I want to know what I’m getting myself into, come to me once you’ve had your first close and some seed assets,’” says Christy Gahr, principal and real estate consultant at Meketa Group. “Then overnight it was ‘I don’t want your seed portfolio, it can’t possibly be worth what it was when you purchased it, and why would I buy into a pool of existing assets?’”

Tjarko Edzes, director of Asia-Pacific at Dutch investor Bouwinvest Real Estate Investors, says that with assets expected to reprice from covid-related market dislocation, investors would not want to buy into “yesterday’s value” by committing to a fund seeded before the pandemic.

“The question is, is that valuation correct today?” says Edzes. “If not, what should it be? And what risk premium is required given the greater level of uncertainty?”

Indeed, global research agency MSCI estimated in April that private real estate asset values could decline 13 to 37 percent under different covid-related scenarios.

“Prior to the virus, specified assets were essential to attract capital,” says Michael Stark, partner and co-head of capital advisory group PJT Park Hill Real Estate Group. “Now, blind pool, dry powder vehicles are likely to have somewhat greater appeal.”

Frank Roccogrande, founding partner at Deutsche Finance International, has witnessed such a change in sentiment from the firm’s investor base. “We are about to have a first close on a successor European value-add fund and it has been a similar discussion. For the first time in a long time, investors view a blind pool as a positive factor because you won’t have the perception of having bought assets at pre-covid values.”

For one North American pension fund manager, a significant pipeline pre-identified before the pandemic would now raise concerns, not only because of the anticipated short-term adjustments in asset values, but also the changing tenant demands that could impact real estate pricing longer term. “Conceptually, there will be a change in behavior that might alter a manager’s pipeline, so the pipeline you have developed might not necessarily be what the market needs now or what it is going to need in the future,” he tells PERE.

For example, having many pre-identified assets in the office sector may no longer be attractive to investors, since the current remote working environment is likely to test office demand in the long term, according to a JLL report. Social networking company Twitter is one of the first corporates to allow employees to work from home “indefinitely” as they wish, according to a statement.

“A pipeline takes time to develop,” the pension fund manager adds. “Especially if the manager has negotiated the price, it is very hard to go back and do it all over again.”

Pipelines not always a negative

But as an investment manager, Stanley Ching, senior managing director and head of real estate at CITIC Capital, thinks it is essential to have a pipeline to show investors how committed the firm is. However, he thinks managers should be actively adjusting the valuation and pricing for those pre-identified assets. The Chinese firm is currently raising capital for an onshore retail fund, an offshore logistics fund and an offshore special situations fund.

Stark agrees some investors are still interested in seeing a pipeline of investments when evaluating a potential fund commitment. “I think investors are curious to see what opportunities will emerge yet,” he says. “First question most investors would ask is, what deals are you actually seeing, or is it still too early to assess relative value? A lot of investors are waiting for more clarity on what the opportunity sets look like and what the risk-adjusted return profiles are across the sector.”

Some investors have sought “creative solutions” to commitment to funds with pre-covid seed portfolios without risking exposure to price declines, says Gahr. “We’ve actually had initial conversations with some GPs to carve out their seed assets – they need permission obviously from their existing LP base – and create a sidecar for any new investors that come in to protect them from that seeded portfolio.”

These restructuring requests typically apply to funds where 20 percent or more of the capital has already been deployed.

Although investing in a fund seeded with assets pre-covid can be risky, the North American pension fund manager thinks the level of risk depends on the types of underlying assets in the vehicle. “Sales in retail or hospitality have been hardest hit,” says the investor. “But if you have a warehouse, anchored by a supermarket tenant, people probably want that even more now.”

Martijn van Eldik, head of corporate finance at JLL Asia Pacific, also agrees that some sectors have proven more resilient and have even accelerated from an investor demand perspective in light of covid-19.

“If you have seeded assets in logistics, data centers or living, they will probably come out stronger after the pandemic,” says van Eldik. He thinks managers with a strong brand, a good track record and a favored sector should be able to raise equity from investors even during covid-19.

According to PERE data, four out of the six funds that reached a final close in Asia-Pacific between March and April 2020 focused on the industrial sector. Both GLP’s logistics income fund in China and Prologis’s logistics fund in Japan were fully seeded at final close.

On the other hand, van Eldik expects managers that made investments in the retail or hospitality sectors before the outbreak to not draw capital for new investments for the time being. “They will wait and keep the dry powder to either defend their positions or to invest when they see some distressed opportunities going forward,” van Eldik says. “Communication with investors is the key.”

Even firms that raised fresh capital after covid-19 expect to approach investments at a slower space. Colin Throssell, head of Europe, real estate at Nuveen, says the firm recently finalized fundraising for a mandate but notes that investors had asked for greater control or discretion on particular acquisitions for a longer period of time than would normally be the case in a fund structure.

“We were quite happy to agree to that,” Throssell says. “We understand that people would rather not dive in too quickly when there are such high levels of volatility and uncertainty, and to deploy their dry powder thoughtfully. Those that enjoyed the skill or good fortune to keep their money back will likely enjoy better performance, certainly in the short term, than those that fully invested in Q1 this year.”