Institutional investors, who over the past five years have plowed billions of dollars into real estate opportunity funds, might be starting to get their fill.
The result: Opportunity funds will likely play a smaller role in the market,a big change from recent years. Another possibility: Some opportunistic funds might simply disappear, while others get repositioned and become “value investors” that aim for less-aggressive returns than those targeted by opportunity funds, in return for more modest fees. Opportunity funds may also become even more active sellers than they have been.
On the surface, though, it seems that sponsors are still finding a receptive audience among investors. An informal survey of several large funds found no fewer than 10 sponsors that have recently completed raising a total of more than $6 billion of equity. When leveraged, that could easily become more than $20 billion of investment capital.
Among those that have raised, or are in the process of raising , capital are , Sterling Equities, $200 million; Lubert-Adler, $520 million to $300 million; Donaldson, Lufkin & Jenrette, $1.2 billion; Starwood Capital Group, $1 billion; Beacon Capital Partners, $250 million; and Cohen & Steers, $200 million to $300 million.
Pension Funds Go It Alone
But players in the market are saying that pension funds, the core investors of many of the opportunistic investment vehicles, are getting more comfortable buying real estate on their own. As a result, they don’t need to plow capital into blind pools that someone else would manage for, in many cases, hefty fees.
Several changes are affecting opportunity fund sponsors’ ability to quickly raise cash,among them a mature market, higher interest rates and the hot high-technology sector.
Because the market is so mature, opportunity funds can no longer rely on the practice of buying out-of-favor properties, repositioning them and selling them at a profit,their modus operandi for the past couple of years.
“The sentiment that you can buy cheaply and sell for more is over,” said an executive at one fund sponsor. “You have to create value at the asset level.”
Maintaining Returns Difficult
Because such “buy-low, sell-high” scenarios are becoming few and far between, it is now even more difficult for the funds to top the hefty 20%-plus returns they promise their investors. Institutional investors that provide equity for opportunity funds know this.
Some funds have relied on large doses of leverage to reach their promised returns,a strategy that will be increasingly more difficult to implement given higher interest rates.
While the number of opportunity funds has grown, the number of institutions comfortable investing in them has remained relatively static over the years.
There are roughly 100 institutions,primarily public and corporate pension funds,that invest in a variety of funds. Each opportunity fund comprises investments from some 20 to 30 investors.
“It used to be only Whitehall (Street Real Estate Fund), Morgan Stanley and Credit Suisse First Boston,” commented one industry watcher. “Now, it’s everyone.”
And the sponsors are going back to the till with far more frequency.
“Money is raised and employed at twice the speed of regular private equity,” said one investment banker very familiar with such funds. “And the investors are always the same ones. They’re not used to the velocity,” he said.
In many cases investors in the first iteration of a fund, who have not yet received much of their principal back, are asked to invest in a subsequent fund.
“You sit in front of an investor. He’s given $25 million for your first fund, then $50 million for your second. He still hasn’t had any money returned. You have to put a spin on everything,” the banker said. But it has never been easy raising capital for opportunistic funds.
Tougher Market
“It has been tough for nine years,” said one fund executive. “When Morgan Stanley raised its first fund, opportunity funds didn’t exist.”
But he added, “It’s definitely taking longer” to raise capital now than three years ago. Back then, he pointed out, funds were smaller than the $1 billion-plus funds that are being raised now.
High-Tech Gaining Ground
The 20%-plus returns that opportunity funds promise, although hefty for real estate, are weak compared to the returns that high-tech securities have delivered over the past year or so. That’s drawn the attention of pension funds, many of which have gotten comfortable with the risks involved. Some observers say that pension funds have, as a result, increased their allocations to the high-tech sector, some at the expense of their allocations to real estate. While opportunity funds generally have finite lives,they must sell all the property they have acquired by a certain time,they are expected to be even more active sellers in the coming year.
According to data compiled by Granite Partners, a New York investment banking boutique, private owners, which in many cases consist of opportunity funds and local developers, sold $14.8 billion of properties in 1998 and $6.8 billion in 1999. And opportunity funds on their own sold $4.3 billion of properties in 1998 and $2.4 billion in 1999.
But many opportunity funds this year will reach the end of their planned lives, creating what may well be a very large sell-off. n
Mandzy is a reporter at VertiNews.com.
