The private equity real estate sector has posted its strongest fundraising figures since the Global Financial Crisis (GFC). With that, there is plenty of dry powder in the market, and plenty of competition for the best opportunities.
An aggregate of US$39 billion was raised in the first quarter of 2019, a continued high number in line with the US$38.4 billion that was raised in the first quarter of 2008, according to JLL figures. Much of this allocation was at the riskier end of the spectrum, with value-added strategies growing by 9 percent, and opportunistic strategies seeing an increase of 22 percent over the period.
With ongoing investor appetite for private real estate, sourcing deal flow remains challenging with record dry powder sitting in funds and increase in co-investment capital alongside funds.
“Current pricing, and competition make it harder for managers to deploy capital or justify the strategies they are undertaking,” says Martijn van Eldik, Head of Funds Advisory, JLL Asia Pacific.
In this environment, a convergence, or ‘redefinition’ of traditional risk and return classifications in the sector is likely with core investors moving up the risk curve in an effort to meet return targets.
Investors are also taking more risk by branching out into emerging sectors or niche markets to find returns, says van Eldik.
“Fund managers who are already in the alternative space are gearing up to provide a range of solutions, from co-mingled funds, co-investments, separate accounts, and programmatic joint ventures, in order to tap into that demand.”
In Asia Pacific, addressing the demand to branch out into under-explored of niche markets, there is growing popularity of single country funds focusing on a single sector.
“While investors may take a longer time to underwrite opportunities in this competitive environment, they remain keen to invest into this part of the world, and especially so in core gateway markets like Australia, Japan, Hong Kong, Singapore and South Korea,” says vanEldik.
Many global investors are still under allocated to Asia Pacific real estate and continue to ramp up investments in the region across the risk/return spectrum. As a result, Asia value add and opportunistic funds continue to see solid inflow.
Over the last several years, notably, the pan-Asia open-end core funds, have been a preferred vehicle for U.S. and European capital to gain diversified core exposure to the region, says van Eldik.
At the moment, it is the mega-funds that are attracting the most capital. Brookfield Strategic Real Estate Partners III raised US$15 billion in Q1, while the Lone Star Fund XI raised US$8.2 billion. In fact, the top ten largest funds to close in the first quarter of 2019 collectively raised US$36 billion of investor capital, according to data from PERE.
“We are seeing a lot of investors consolidating their portfolios, and reducing the number of managers they work with. They tend to go with the bigger brands with top quartile performance. The big get bigger, basically,” says van Eldik, pointing out that mega funds tend to have the ability to provide greater incentives to investors who are prepared to commit capital. They also tend to have a wider investor base to begin with.
But, due to the drive to find better risk-adjusted returns by investors, smaller fund managers with a strong track record in niche sectors or emerging markets have also benefitted from good capital inflow.
Larger, more sophisticated investors are increasingly pursuing direct investments and separate accounts over comingled funds, which means that fundraising may potentially take longer going forward. It may also take longer to reach targets as investors make smaller commitments to funds, says van Eldik.
Negotiation on fees and terms, especially if investors feel they are taking on more risks for the ‘same level’ of returns, combined with demand for transparency, and faster information, means that fund managers who are not prepared for such investor requirements might take longer to fine tune their process or incorporate new technologies,” he says.
Click to read more about why investors are more selective as uncertainty takes its toll.