There’s this really nice bridge spanning New York City’s East River and it’s for sale. So you’d like to buy this bridge? And you’re going to use private equity dollars to do it? At first blush the blending of private equity – oft considered an ok investment by many – and real estate – still the barely breathing victim of subprime antics and the recession – may not seem like the best possible investment partnership. You might not raise the funds for that East River bridge, but the cozy co-habitation between real estate and private equity this year might just surprise you.
A new report from the experts at Preqin (click here to download), notes that while nowhere close to the heady days of 2006 and 2007, there are signs of confidence slowly returning to the blended private equity real estate industry.
“The sluggish fundraising results from Q1 2011 reveal that we are far from returning to the levels of 2006 and 2007, but with more interim closes taking place we are at least seeing some momentum returning,” states the report.
Based on conversations with institutional investors, the report concludes that there is an increasing appetite for private equity real estate and that institutions are now considering new opportunities more actively than a year ago. (See chart below.)
Did the funds themselves do what they were supposed to do to serve their investors? Some of them, according to Preqin. As the chart below shows, the performance quartile breakdown of North America-focused funds of 2003 "“ 2008 shows that they generally did ok, though the smaller ones actually proved more successful.
54% of funds that raised less than $500 million outperformed the median, with 30% being ranked as top quartile and only 21% ranked bottom quartile. In contrast, 60% of those that raised $1 billion or more are currently producing third or fourth quartile returns, with only 23% producing top quartile returns.
Still, the report does find that the fundraising market remains extremely overcrowded, with more funds in market than at any other time in the history of the industry.
“While some firms have achieved considerable success in recent months, many others still face the prospect of long fundraising periods, with no guarantee of success,” Preqin notes.
As of April 2011, there were 441 private equity real estate funds in market, targeting an aggregate $159 billion. The number of funds on the road increased by 3% in Q1 2011, and the aggregate capital targeted by these vehicles was up 15%, leaving the market crowded.
The aggregate target of all funds in market is now higher than the total capital raised in 2008, and nearly four times the amount acquired in 2010.
Of the 441 funds in market, 240 are primarily focused on North America and they are seeking an aggregate $87.0 billion, 55% of the capital being sought by all funds of the road. Europe-focused funds are targeting the second-largest amount of capital; 113 funds are targeting an aggregate $42.2 billion, 27% of all capital sought.
And what does it take for a private equity real estate fund to attract new capital? A consistent track record is one of the most important factors for an investor considering a new commitment. Investors want managers that have a proven ability to produce strong returns in a variety of market conditions.
The report notes that consolidation is likely to ramp up as funds realize they can’t make it proper go of it on their own, and that there’s strength in numbers "“ CB Richard Ellis Group’s acquisition of ING Real Estate Investment Management is an example.
With interest rates still near zero and a tenuous but going-in-the-right-direction economic recovery underway, perhaps real estate – and private equity funds that invest in it – will continue to do well for investors.
Mind you, with competition for institutional money particularly fierce, and with the jury out on whether real estate in particular can withstand more tumult in Europe and the possibility of more economic retrenchment in the U.S., that bridge may be the best investment of all.
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