Distribution Slow Down

A panel of three fundraising experts from TPG, Monument Group and Triton Pacific Capital discuss the winners and losers of the real estate capital raising market, the impact of slowing distributions on allocations and investor appetite for co-investment rights.

PrivcapRE

What’s the reality on the ground for real estate fundraising, and how does it compare to the past?

Lori Campana, Monument Group

The activity and demand on the private equity side and the movement of investors is much faster than on the real estate side. There are more distributions coming back in real estate, but not as rapidly as in private equity. Sometimes real estate is frustratingly slow.

PrivcapRE

Distributions for private equity in 2012 were significant—it’s one of the best years. Is that not happening for real estate?

Robert Weaver, TPG Capital

I was on the phone recently with an investor who has a relationship with a GP who said they expected to return $900 million of distributions this year. They ultimately returned two-thirds of that, which is still a ton of money, but less than what the LP was budgeting and it affected their internal calculations for future allocations for the 2013 vintage year. There has been a lot of liquidity, there have been a lot of distributions, but on balance, for 2013, it will have been slightly less than people were expecting at the beginning of the year. That has ramifications for whether investors do that next fund. If they do, do they put in $50 million, $100 million or a different size? Distributions in 2013, while strong compared to the last five years, haven’t met peoples’ expectations.

Lindsey Sugar, Triton Pacific Capital

Distributions should pick up pace. There should be distributions from funds eight, nine, 10 years out. They’ll still be good returns, but it’s not going to be as robust as in the earlier part of 2013. It will be more comfortable for managers to say, “this is much more of a normalized environment, we should sell now.”

PrivcapRE

How slow have distributions been in getting back to the LP?

Campana

It’s been slower than people wanted. It wasn’t long ago that they invested in the last round of funds, 2010 through 2012 vintages, and that money is still invested or reserved for future capital calls. They’re starting to see a few realizations from that but it has been slow, and as a result, so have new commitments.

Sugar

On the whole, vintage 2005, 2006, 2007 funds, have exercised their first extension options, or sometimes second. Your extension option is to draw out the fund term and hope they’re returning as much capital to investors as possible. This creates slow capital return to investors and often times less is being distributed than was committed in the first place. We’ve seen instances where investors say, “yes, we would like to invest in your next fund, but we really need the capital back from the prior fund to make that happen.” In 2013 some investors, including large public pension plans, sold off some of their commingled fund interest in the secondary market, looking to purge less-than-positive-performing assets and get back in the market. Others have chosen to wait it out.

PrivcapRE

Is it a case of needing to get back into the fray quickly before the opportunity closes? And the LPs need the capital to do that?

Sugar

Other pension funds did the same over the summer [of 2013], not trying to stop the bleeding, but to cut their losses, move forward in their investment plans and put capital out.

Weaver

One of the things that continues to be true is that many investors are consolidating their GP relationships, and as money becomes available for new commitments, they tend to be doing more with fewer people. That’s beginning to create an environment of winners and losers among the manager community.

PrivcapRE

Will the capital-raising winners be big, broad and global GPs?

Campana

Actually, no. There’s still that attraction to the larger manager, of course, but it depends on the investor. Some investors are still relatively new or have bigger allocations, but they want to allocate to fewer managers, so the global strategy makes sense. There are a lot of people who have to fill out their portfolio or believe that the niche managers might provide more alpha, so they are looking for niche, smaller or regional strategies.

Weaver

One of the biggest trends going on right now is LPs are much more concerned about who their peers are in the funds. A lot of the big guys and small guys alike would rather be invited to a dinner party of 20 than one of 75.

PrivcapRE

We’ve all seen the headlines of several funds, large and small, being over-subscribed. What does it take to be part of that group?

Weaver

The fundraising process sometimes becomes a momentum machine. Oftentimes there’s a spark and you go from a fundraising that is plodding along to one where people are running for the entrance.

Campana

It starts with right-sizing your fund, and knowing your investor base, setting your terms appropriately for your key investors right from the get go. Consultants are even more important to the process than in prior vintages.

Weaver

There’s still plenty of room for mid-sized managers, but the bar to become a new GP is a lot higher than it used to be.

PrivcapRE

Lori, how do you right-size a fund?

Campana

Right-sizing a fund can make or break a fundraiser. You have to have it large enough to attract the big checks, but small enough that certain investors feel like they have some say within the funds. And right-sized well enough to make sure you have a successful fundraise, but still ensuring the GP has the right amount of capital to execute a strategy.

PrivcapRE

Where are LPs negotiating most? Is it fee terms or co-investment rights?

Weaver

The most thoughtful investors are not asking for everything all the time. They are legitimately concerned about the J-curve, and fee structures that can take a bit of the edge off. They are also looking for co-investment opportunities [saying] “help me with my overall fee load and allow me to overweight the deals where.”

Campana

The co-investment issue is a struggle for many GPs, as they need the right-sized fund to generate appropriate management fees to support their strategy and management of the organization and knowing that co-investments don’t generate as much in fees. Many of their key anchor large investors are asking for it. Some LPs want to make sure if there is an opportunity offered, they are in a position to consider it. Other investors are adamant that co-investment opportunities are driving their strategy, so in some cases they invest in a fund as a way to get the co-investment and to reduce their overall fees.

PrivcapRE

What are your expectations for real estate fundraising in five years’ time?

Weaver

I hope fundraising doesn’t get as frothy as it did during 2004 to 2007; that we have a market that’s in relative equilibrium, where there has been more capital allocated for alternative assets, including private equity, real estate and real assets.

Campana

Real estate has always been the dominant asset class in the real assets bucket. Where investors were disappointed in real estate managers and/or their performance over the past five years, they have looked to expand their portfolios elsewhere, particularly energy portfolios. They’re looking at other real asset alternatives in addition to real estate, which is oftentimes competing against not only other real estate options, but other real asset options like infrastructure, as well.

Sugar

GPs have taken in a lot more foreign capital than ever before. Diversifying the investor base is crucial, and building loyalty and certain types of strategies lend themselves to foreign investors. You hear stories from China, in particular, where investors don’t care what their return is as long as they’re not going to lose money. With the instability in capital markets in China, it seems like a safer place for them. A large amount of foreign capital is likely here to stay.