Although investors in private real estate funds are now more sophisticated than ever and are conducting even greater levels of due diligence on potential real estate fund commitments, it remains extremely difficult for institutions to identify the best opportunities. This blog examines the challenges investors face with fund selection, as well as why investors continue to be attracted to investing in private real estate.
The private real estate fundraising market remains extremely crowded, with 450 closed-end private real estate funds in market targeting aggregate commitments of $162bn. There are a diverse array of funds offering investors exposure to a wide range of strategies, property sectors and risk profiles. A significant proportion of funds in market incorporate a combination of at least two strategies. As a result, it can be difficult for investors to identify the funds that will help them best meet their desired portfolio composition and offer the potential to generate strong risk-adjusted returns.
Another concern for institutions investing in real estate is that the competitive nature of the fundraising market means that not only are there a wide range of funds vying for investor capital, but also in many cases, managers may not be able to successfully raise the funds they are marketing. Investors may be forced to make a judgement not just on the attractiveness of a fund as an investment opportunity, but also on whether the manager will be able to raise sufficient capital for a fund to be viable. One hundred and fifteen closed-end private real estate funds were abandoned between January 2012 and May 2013 and, of the funds in market that have yet to hold an initial close, 45% have already been on the road for more than a year. It seems likely that many managers of these funds will not be able to successfully close these offerings.
Real estate remains attractive to many investors for several reasons. Real estate portfolios can offer diversification, act as an inflation hedge, and provide a steady income stream. Most investors, however, will still expect real estate, and in particular private equity real estate funds, to offer strong performance compared with traditional investments. The financial and liquidity costs associated with getting access to private equity real estate funds mean that returns above and beyond other asset classes are required to justify investors’ commitments.
The vast majority of institutional investors with an allocation to real estate remain committed to the asset class, with 52% expecting to maintain their allocation in the longer term and 39% planning to increase it. However, navigating the private real estate fund market remains difficult for investors. With a large number of managers vying for investor capital, and an increasingly diverse array of fund offerings, fund selection is very challenging.