Fundraising Slows Down for Private Equity Real Estate Funds

Fundraising Slows Down for Private Equity Real Estate Funds

Private equity fund managers may be focusing more heavily on deploying their record levels of “dry powder” as fundraising activity shows signs of slowing.

Although fundraising remains strong by historical standards, new capital flowing into global private equity real estate funds took a big step back in first quarter. According to London-based research firm Preqin, 44 funds closed with a total capital raise of $21 billion. That is roughly on par with fourth quarter 2015. However, activity is down 48 percent compared to second and third quarter closings in 2015.

Commercial real estate services firm JLL also noted a slowdown in private equity activity. The firm tracked $12.7 billion in closed-end funds that closed in the first quarter, a figure that was 27 percent lower than the one recorded in the first quarter of 2015. “I think this is happening hand-in-hand with some of the macro-uncertainty and volatility that we saw in the first quarter. It almost mirrors the decline we saw in investments sales activity,” says Sean Coghlan, director of investor research at JLL.

In particular, there has been a marked slowdown in mega-sized private equity fund closings. Over the past two years there was a big expansion of $1 billion-plus funds. Fifteen funds that totaled more than $1 billion closed in 2014, and in 2015 that figure increased to 18, according to JLL. During the first quarter of this year, there were only two such mega funds that closed. That decline is likely due to a combination of factors, but the recent volatility is certainly one, notes Coghlan.

It is important to look at those first quarter numbers with a little bit of caution, according to Mike McMenomy, global head of investor services at CBRE. There could have been some large fund closings last year that skewed the numbers a bit. That being said, public pension plans is one group that is slowing its real estate investing. Pension funds are generally at target goals related to real estate allocations and are not feeling pressure to put more capital into real estate right now, McMenomy says. The real estate market is also more than six years into its recovery. “So the capital dollars to deploy at this point in the cycle will be done so with greater scrutiny and greater selectivity,” says McMenomy.

In order to attract capital, fund sponsors are going to have to demonstrate a lot of competency and proven success, as well as a competent strategy based on how they see the marketplace unfolding over the next three, five and seven years. That shift in sentiment will likely result in a bigger gap in fundraising success between the strongest funds and some of the new or less-established fund managers.

“The winners are doing fine. There is ample capital there. If you are somehow just off the fairway, life will become more difficult relative to capital raising,” says McMenomy.

Regardless of whether the first quarter slowdown in fundraising is a temporary pause or sign of a bigger slowdown ahead, most private equity funds are currently in a good position. According to Preqin, real estate funds have a record level of “dry powder,” or available capital, at $230 billion. That surplus is due to past fundraising success, as well as some of the challenges related to investing available capital in a highly competitive investment market.

The capital that has been raised has certain mandates related to acceptable risk and return levels. If fund managers don’t believe the market can deliver those results, they are not likely to be aggressive in pushing money into deals just to get money out the door. “Speaking for our firm, we intend to be patient, and I think the marketplace is being patient, because transaction volumes are down considerably,” says McMenomy.

However, some private equity funds may be stepping into the lull in acquisition activity created by market uncertainty. JLL noted an uptick in investment activity from private equity funds during the first quarter. Last year, institutional buyers, both domestic and foreign, were driving most of the investment sales activity. This year, private equity funds are being more effective at deploying capital and identifying transactions, says Coghlan.

Private equity funds also are using available capital to go after very large deals. Starwood, Blackstone and Heitman have all closed on big portfolio acquisitions in the first quarter. “So I think we will see that dry powder number start to decline as we move forward into the year,” says Coghlan.

Private equity capital is also more willing to go after suburban office and suburban garden-style apartment properties, bringing more liquidity to those sectors of the market, he adds,

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