Dr Bernhard Koehler, CEO of Pfaeffikon-based Swisslake Capital AG, examines the activity of real estate private equity funds (REPE) funds in Q3 2009.
1. Market Overview
In the third quarter of 2009 we have recorded the launch of 67 new real estate private equity (REPE) funds. Although this is an increase compared to the 65 vehicles launched in Q3 08’ the target equity volume decreased by 34.5% to USD24.17 billion. Note that in contrast to Q3 08’ where the geographical allocation of funds was much more diverse, in this quarter European and US funds account for more than 90% of new launches.
Just as we suspected, fund managers are not giving up on new vehicles due to what they believe are immense opportunities created by the global crisis: they are just becoming more realistic as to the volumes they can raise. As the recession nears its end, investors are in the process of establishing new strategies. Although the denominator effect is not the main topic anymore, over-commitments and reallocations of portfolios by Large US pensions funds and other REPE investors such as sovereign wealth funds and insurance companies still is. We have also seen many endowment funds and insurance companies trying to sell their entire portfolios on the secondary market before making any future investments.
Many investors have also become much more demanding in terms of due diligence process, delaying often initial commitments which can be a decisive factor for other investors to step into the fund.
2. Average Fund Size Still Decreasing
The third quarter of 2009 witnessed the launch of only 3 new funds having a greater target than USD1bn compared to 7 for the same quarter in 2008. In contrast 8 small funds, defined as vehicles having less than a USD100mn goal, were launched in Q3 09’ against only one in Q3 08’.
Therefore it comes as no surprise that the average REPE fund declined from USD568mn in Q3 08’ to USD361mn in Q3 09’. As depicted on the graph on the left, roughly 85% of funds launched in Q3 09’ were targeting USD500m or less compared to 70% in Q3 08’. Even big names and renowned fund managers who are used to launching several billion funds on the market have reiterated their goals to more realistic figures.
Perhaps this is not such a bad twist, as fund managers will be forced to select their investments with more care, perform stronger and deeper due diligence on each potential investment and finally as they will have less assets to manage, the value-add and asset management itself could potentially be enhanced.
3. The Risk-Return Profiles are Shifting
Although opportunistic funds retain the largest portion of the market there is a strong increase of value-add and core funds signalling that fund managers are perhaps seeing the end of the recession. Whereas in the third quarter of 2008 almost 70% of all funds had an opportunistic strategy, in Q3 09’ the situation seems to be slowly shifting to good all core and value-add real estate investments. Value-add funds make 30.7% of the REPE fund market, almost double the size a year ago and core funds increased their market share from 13.8% to 22.7%. This significant shift indicates that fund managers are starting to see the stabilization of yields in the US and most European markets. This coupled with rent stabilization, which is yet to occur in many markets, will create again the opportunity for value-added and core strategies.
However opportunistic funds remain in majority with 44.6% of the market share mainly due to high return expectations by these fund managers that are convinced to profit highly from a large number of distressed sellers. Unfortunately for these fund managers we are yet to witness this waive of distress selling as banks are rather restructuring loans than seizing the assets, something which more and more players in the industry are calling “extend and pretend” or “delay and pray”.
4. Europe and US account for 90% – No interest in Asia
The graphs on the left say it all, it’s back to the roots for REPE fund managers. The first signs of a recovery of the REPE industry come from Europe and the US.
The US remains the most active market for REPE fund managers in Q3 09’ with 35 new funds launched. This is a slight increase compared to the 29 funds launched in Q3 08’. However, the total NAV target decreased slightly in Q3 09’ by 6% to USD12.12bn against the USD12.93bn in Q3 08’ indicating that the average US fund got slightly smaller. Again, fund managers are more and more conscious of the reduction of commitments by their usual investors.
In Europe 26 new funds were launched in Q3 09’ compared to 18 funds for the same period in 2008. The total target NAV rose by 15.9% to USD10.88bn compared to the USD9.38bn targeted in Q3 08’. One of the main factors here is, the bottoming-out of the UK real estate market (11 out the 26 funds launched in Q3 09’ are pure UK funds) and the numerous buying opportunities in stable core markets such as France, Germany or the Benelux countries.
5. Europe and US account for 90% – No interest in Asia
In Q3 09’ roughly 95% of the equity targeted by the managers was aimed at the US or Europe. Many fund managers with little experience burned their fingers rushing to Asia when the world economy was booming and China and India emerging. Fund managers are either stuck with capital raised last year with few good opportunities while others see no prospective in raising equity for new funds from US or European investors. This explains partly the fact that only 3 Asian were launched targeting less than USD1bn.
It is important to note that apart from a few exceptions , the majority of Asian investors tend to invest directly themselves. The reason why we point to this fact is that according to RCA Analytics, the highest transaction volume in 2009 has been recorded in Asia Pacific. This is mainly due to the transactions on a few markets such as Beijing, Shanghai, Tokyo or Sydney where many local investors are trying to seize opportunities before the markets bottom-out.
6. Debt & Residential in the US – Commercial in Europe
Right behind diversified funds, debt funds remain the most attractive strategy amongst fund managers with 26.4% of the market share in Q3 09’. However 13 out the 15 new debt funds were launched in the US and were targeting USD5.80bn in Q3 09’: a clear sign that the lack of liquidity still persists in the US.
The CMBS market is still frozen and banks are mainly restructuring loans requiring more equity, leaving a widening gap between common equity and senior loans. Mezzanine players are more and more frequent to fill this gap and with banks starting slowly to seize assets, some managers are also launching senior debt funds to tap distressed owners not wishing to abandon their investments.
Right behind debt funds are residential funds. 12 new launches targeting USD3.34bn out of which 8 funds were launched in the US. Demographic fundamentals are still strong in the US and with many cities having witnessed prices decline by more than 50%, many managers believe that is a buyer’s once in a lifetime opportunity.
In Europe there seems to a greater focus on commercial property than on residential or debt. 7 new office funds were launched in Europe targeting a total of USD3.60bn in equity. All of these European office funds are targeting the major western cities such as London, Paris, Munich, Amsterdam, Berlin, etc…
Another point worth noting is the increase in the specialisation factor of fund managers. Whereas for the same period last year, diversified funds accounted for more than 70% of the market, in Q3 09’ only 30.7% of equity was aimed at diversified strategies. Pure office, residential or retail funds are becoming more and more frequent. This pertains to geographical diversification as well. We haven’t recorded a single global fund in Q3 2009.
We cannot say with certainty whether this is a long-term trend or if fund managers will return to mixing asset classes and buying everything once things return to normal.
