Capital Market Growth: Frenzied And Frantic Or Calm And Cautious?

Increased interest from investors in real estate has created unique opportunities and challenges for investment managers.

At Thursday's Bisnow event in San Francisco, Juniper Square CEO and co-founder Alex Robinson moderated a panel of investment managers who discussed the state of limited partnerships and real estate, where capital is coming from, what investors want and how the regulatory environment is affecting investments.

Robinson said a typical institution’s allocation in real estate is now 10%.

“There has been a big wall of capital and a big flood into real estate, but at the same time it takes a record amount of time for a manager to raise a fund unless you are Blackstone or another large fund,” Robinson said.

StepStone Global partner Brendan MacDonald said it is a good time for raising LP capital.

“Real estate is viewed as a darling asset class globally in a world where interest rates are very low and equity markets are fully priced,” MacDonald said.

Real estate private equity is growing as a class for institutional investors, adding a new pool of capital. He said for established managers with proven track records, it is an attractive time to raise money.

For emerging managers, it is tougher. Limited partnerships are paring down their manager relationships. Foreign money coming into this asset class has more comfort with some of the stronger, recognized brands. MacDonald said this does not mean it is a bad time to start a new investment shop. There is about $200M of dry powder held by fund managers who will partner with new operating teams, he said.

Prologis managing director Alison Hill said capital-raising is easier than five years ago, but not as easy as 2006.

“It’s a good time to be raising capital, but it doesn’t feel like a crazy time to be raising capital,” she said.

Investors have been looking more across the spectrum and have different buckets where they want to allocate capital, Hill said. There also has been less emphasis on core investment. Investors are shifting into more core plus or high yield debt as an alternative source to add more juice and a bit more yield than they can get with core, according to MacDonald.

Investors also are shifting toward industrial. Historically investors did not want to build up portfolios in industrial because they take a long time and the deal-by-deal size is very small and takes a lot of people. As industrial has become a typical asset class, more people have invested in it and are starting to buy small funds, according to Hill.

Prologis has had a lot of big sovereign wealth or public plans invest through its funds over the years. Now some of the bigger funds are starting their own competing platforms while they still have investments with Prologis.

Opportunities For LPs

For smaller funds that may not have resources of larger endowments of sovereign funds, co-investments are becoming more popular. These LPs are looking for one-off transactions on a low-restricted-fee basis where they are just paying on the investment capital, MacDonald said.

Invesco senior director Tracey Luke said co-investment is a great opportunity for investors to get their capital deployed to get lower fees and more access to deals they would otherwise not have. At the same time, she said expectations need to be tempered because co-investments might not sit well for certain LPs, and they do not move at the same pace the limited partnership may be accustomed to.

Investors are building in-house investment teams on a direct basis, but that is reserved for a select group of LPs that have the resources to do so. StepStone advises LPs on selecting managers and managing their portfolios and helping them direct capital to funds. It also assists LPs with one-off investments and helps them take advantage of some of the co-investments.

How Regulations Are Impacting Managers

Following the global financial crisis, there has been an increase in thoroughness and due diligence. Luke said specialized due diligence teams are being used in Europe and are starting to be used in the U.S. more.

Luke said this type of due diligence can be good for managers because it can be potentially more efficient. These teams know what they are looking for and can guide discussions. At the same time, managers have to have the right people in the back office, including compliance, legal, accounting and closing, or they could lose business.

The regulatory environment has made it particularly rough for investment managers. The U.S. regulatory environment continues to be onerous and the European Union is not much better. The European Union’s Alternative Investment Fund Management directive has provided additional regulatory burdens and additional reporting. Hill said managers have no choice but to do all of the necessary reporting. Regulatory burdens have increased managers’ compliance and legal departments. Investors expect due diligence to be done well, and they do not want to hear that it is tough.

“That’s great for longevity and job security for compliance and legal, but it’s not something that is really adding value to investors, particularly in real estate,” Luke said.