April 1, 2012
Interviewed by: David Snow
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Tough Love From Investors

What is going on in the private real estate fundraising market? How have investor appetites and expectations changed?

Gain critical market insight into which managers will be favored by investors in a transformed market from Todd Henderson, Head of Americas for RREEF Real Estate, Sonny Kalsi, Founding Partner of GreenOak Real Estate, and Stephen Tomlinson, a Partner with Kirkland & Ellis.

Topics discussed include: How and why investors are continuing to commit capital to private equity real estate funds, the continuing strong global demand for property assets, the “barbell effect” on the market, the importance of a differentiated strategy, and which manager attributes are viewed favorably by investors.

What is going on in the private real estate fundraising market? How have investor appetites and expectations changed?

Gain critical market insight into which managers will be favored by investors in a transformed market from Todd Henderson, Head of Americas for RREEF Real Estate, Sonny Kalsi, Founding Partner of GreenOak Real Estate, and Stephen Tomlinson, a Partner with Kirkland & Ellis.

Topics discussed include: How and why investors are continuing to commit capital to private equity real estate funds, the continuing strong global demand for property assets, the “barbell effect” on the market, the importance of a differentiated strategy, and which manager attributes are viewed favorably by investors.

David Snow, Privcap: We’re joined today by Todd Henderson of RREEF Real Estate, Sonny Kalsi of GreenOak Real Estate Advisors, and Steve Tomlinson of Kirkland & Ellis. Gentlemen, welcome to Privcap today.

So we’re talking about real estate, but I’d like to talk about real estate as experienced by the providers of capital to the private real estate, the limited partners, the investors around the world. It’s very good prism through which to understand the broader trends in our asset class. If we’re talking about investors and how they feel about real estate that is manifest in the fundraising market, Steve, you’ve got a great view of fundraising, and helping many clients with fundraising processes. Why don’t we start with what you’re seeing right now by way of trends in the private real estate fundraising market.

Stephen Tomlinson, Kirkland & Ellis: Sure. We are happily active in the fundraising part of our practice now. We have over 30 different groups we’re working with funds to the market, which is a sea change from 12, 18 months ago. I think pretty consistently, and these range from very focused niche strategies– many offshore– to traditional, global opportunistic players.

Everybody’s complaining about how hard it is to raise money, but they’re doing it. So I think it’s a longer, it’s a more difficult process. But it’s one that’s actually taking place. There’s lots of pressure to get first close investors circled and to the table and signed. That is manifesting itself in economic and other fund terms that are very much at play.

Lots of discussion about what’s the market for a first close concession? There’s a lot of data points out there that people can look at and think about how it affects them. So it’s difficult to get people to the table. But they’re taking meetings and they’re at least willing to listen to the pitch. That’s changed in their committee.

Snow: It sounds like investors still want real estate, but they want it in a different way. They want it from different people. They want it in a different structure. Todd, what are you hearing from investors and their appetite for and their understanding of real estate as an asset class?

Todd Henderson, RREEF Real Estate: They’re not moving away from the asset class, they’re moving into the asset class. The world from which we, as institutional investment managers, the world has expanded for us where we would raise capital.

We’re importing significant amount of capital from areas of the world that we didn’t import capital from before the crisis. I would say the demand for US real estate, in particular, is as high as it’s been for offshore investors in quite some time. That group of offshore investors is very diverse, from sovereign wealth funds, to pension funds, to retail, to high net worth individuals. I think that the US market as well, is beginning to show some signs of increased demand for real estate.

So I think that investors are moving away from Europe today, and they’re focused on the more stable or higher growth economies from a macro perspective and that’s the US and Asia.

As long as the equity markets continue to grow, then the real estate market is going to do quite well from the standpoint of institutional investors. We won’t have the denominator effect associated with capital availability from institutional investors that we saw happen to us in 2008, 2009, as equities and fixed income portfolios depreciated faster than the real estate portfolios.

We’re now seeing new allocations from institutional investors because they do have some capacity within their stated objectives for how they allocate capital real estate portfolios.

Snow: So Sonny, if investors wanted one version or a set of versions of real estate leading up to 2007, 2008, what has changed? What do they want now? What parts of the 2007 mix are they saying, no, that’s no longer a part of our portfolio?

Sonny Kalsi, GreenOak Real Estate Advisors: It changes. So I think that if you were to have asked a lot of investors in ’09– in ’08 they probably wouldn’t have to spoken to you. If you got them in the second half ’09, first part of ’10, they would have said, “We’re never going to invest in the big, global commingled, opportunistic fund ever again.” That’s clearly not the case anymore.

But I would say just broadly, investors want more alignment. So whether it’s economic alignment, co-investment from the general partner, they want more governance, they want more say. Clearly there’s a big push, certainly from a lot of the big sovereign wealth funds have been very focused on separate accounts, or doing club deals, and doing other things.

One of the things I’ve learned in the industry in 22 years is you have to be careful that being too reactionary to kind of what you’re hearing right now. There’s no question, as Steve alluded to, fees have come in. They’ve tightened. I would say governance has also tightened. Those things are probably appropriate. Certainly relative to 2007 vintage fund if that’s what you’re comparing it to.

Then what I’ve seen at least is that you have a little bit of a barbell form where on the one end you’ve got a couple of big organizations. Blackstone is the one that’s been in the press the most, having a fair amount of success capital raising and they should. They’ve got a good track record. They have a great team. They’re one of the few people left kind of in that end of the market. I’m not surprised that they have a lot of momentum. I’m talking, obviously, about opportunistic funds here.

Then on the other end of the spectrum, we have a lot of new entrants. Now, I heard a stat the other day from a good source that said that right now in the US there are 400 first time funds out– 400 emerging managers trying to raise money. There’s a bit of a definition around that. Could be a first or second time fund. 250 of them are trying to multifamily, which is a little bit of a statement about multifamily. We could have another discussion about that.

Of that group, they’ve been in the market, on average, for 18 months. Of that group, 10% has raised any money, $1. And five, only five have actually hit their targets. So there’s a lot of choice there. There are a lot of new people out there. But they are raising money. It’s painful. It takes longer. The economics are not as attractive as they used to be. But by and large, capital is there.

My view is, certainly from an investor perspective, ultimately what you want to do is you want to find someone who you think knows what they’re doing, you have the right alignment with them. Then you want to be investing. Because I think from a vintage standpoint, this is going to be one of those time periods where you’re going to look back on this time period and say, I wish I was in the market. Those people that were in the market, I think are going to generally be happy about it. Those people who spent a lot of time hemming and hawing are probably going to look back on it and say, we missed something.

Henderson: It’s interesting, to Sonny’s comment about those that are raising money and those that aren’t raising money. It’s not surprising to me because the large providers of capital to our industry are reducing managers. So new entrants or emerging managers are having a much more difficult time than those that have significant track records and produced significant results. Managers are going deeper with fewer that have good track records.

I would also say that not only is there a barbell between those that have track records and emerging managers, there’s a barbell around strategy today. The market seems to be raising a fair amount of capital, albeit slowly. Much more slowly than they had historically done. Therefore, there’s a lot of complaints about the time it takes to raise a fund. But it’s happening in the opportunistic end of the spectrum. It’s happening on the core end of the spectrum. In between, there is not a lot of capital being raised in between.

Tomlinson: A harder strategy differentiation argument to make in the in-between.

Henderson: Absolutely. Absolutely. I think one of the challenges that the opportunistic space is having is that the plan sponsors have a lot of– still, today, have a lot of unfunded commitments. So it’s difficult for them to make new allocations to a strategy, even if they like the strategy and they like the manager, because they don’t know about those unfunded commitments and how much capital they’ll really have available to them. So they’re trying to work through these unfunded commitments in the higher risk, higher return space, in order to get the capital to do the strategies that they like. It’s a slow process, but I agree that it’s happening.

Tomlinson: So deal flow is a key driver of the ability of people to make new commitments, or willingness of people to make new commitments. Unfunded, and call capital from prior commitments, but also just the ability to demonstrate the strategy through its execution by pointing to what you’re going to do with the money. And make a convincing presentation about why that deal flow will be there. Because it’s just very difficult for most market participants to feel comfortable that they can gauge that.

I also think there’s price discovery of a sort taking place, which is one of things that’s slowing down the fundraising cycle. Which is price discovery in terms of fees. Everybody’s under pressure. I mean, there have been some very, very well-known, highly regarded, successful sponsors who have quite publicly come under a significant fee pressure. It’s been in The Wall Street Journal, other places. So that’s happening and that price discovery slows down the process.

On governance and some other non-economic fund terms, I think there’s also a form of price discovery taking place in that people say a lot of things that they want and when you sit and go through the process with them of negotiating what that actually looks like on paper, and the responsibilities that come with rights, and the potential issues, that can create– what you tend to observe often is a be-careful-what-you-wish-for reaction of maybe I want that, maybe I don’t, I’m not so sure.

That just, again, it slows down the process. Not of any bad intention, but just the reality of needing to reinvent parts of the model that people didn’t spend a lot of time thinking about. Now are thinking a lot about, but aren’t so sure they actually have a better answer. So we spend a lot of time thinking, well, maybe we could do this, maybe we could do that. Lawyers are good at that, but that doesn’t make for a fast process.

Snow: I’d like to pick up on something that we talked about here earlier, which is the idea that there’s consolidation. There’s a desire to have deeper relationships with fewer managers. Another deja vu that’s happening in the private equity side of the market as well. This could be our final question, but what are some of the factors that are separating the chosen few that remain in a relationship with the investor versus those that say, “Her,e no thanks,” for the next time around? Clearly, track record is important. Is there anything else beyond track record that helps a manager remain with the investor for the next round?

Kalsi: Strategy. There is the strategy that the manager pursuing in line with what the investors view is of the market opportunity right now? So do they have a differentiated strategy? Do they have the ability to execute what they’re saying? That’s obviously very important.

I think people are also very focused on platforms and sustainability of platforms, stability of platforms. That’s very important. There’s been a huge amount of dislocation in the industry, in terms of people, in terms of businesses. I think a lot of those thing come in. I still think track record and kind of the history is the most important. That’s really the single-most most important thing.

Henderson: I think that’s right, Sonny. Everything you said is absolutely what they’re focused on. I’d just put maybe a finer point on track record. If you were in the market through the downturn, you suffered. So there are many folks that are grading on a curve. How did you react? How did you communicate? What did you do as a firm to support the products? Did you reduce fees? Did you bring additional capital to situations in order to suffer, if you will, along with the investors? So that curve of performance, there’s a lot of factors that go into that other than just nominal what you produce.

Tomlinson: Could not agree more with what Todd just said. I think one thing we are seeing is those of our clients who were proactive about getting to their investor base when things were clearly bad, and likely getting worse, and engaging them, and being as transparent as possible, and really trying to be to their investors first with both the questions and potential answers. Might be relief in fee, might be relief of commitment, whatever it might have been, are the people who have the easiest time explaining away what, from a vintage standpoint, is pretty industry-wide.

But people reacted very differently. I think Todd has put his finger on a very, very, important factor.

Snow: Well, It sounds like as investors are looking to the next era of real estate investment, they would like to partner with groups that show themselves to be good partners during the bad times. You can look at track record and that’s all good, and compare two different numbers against each other. But the groups that were good partners and transparent and proactive have an advantage in today’s fundraising market it sounds like.

Tomlinson: It shouldn’t be a surprise, but we all need to be reminded of that sometimes.

Snow: Well, this is the fascinating conversation. It’s a hot topic obviously. So Privcap would like to return to real estate fundraising, certainly in the future. And when we do, maybe we can have all of you back to give us an update.

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