When a private equity firm the size of Blackstone introduces a new investment strategy, the market sits up and pays attention.
This is precisely what happened when it launched its Blackstone Property Partners fund, which completed a $1.7bn (£1.1bn) first close in December last year for investment on both sides of the Atlantic.
Traditionally an opportunistic investor, and one of the most successful of the companies operating in the sector, Blackstone’s new fund added a core-plus strategy to its roster of investment styles.
In addition to Blackstone, others looking to branch out from their traditional opportunistic beat to consider more core investment products include Internos Global Investors, Infrared Capital Partners and Moorfield Group.
The raising of funds for Blackstone’s new strategy came at a time when the property market, particularly in the UK, had been attracting a wider and more global set of investors than at any point since the financial crisis.
As Stephen Barter, chairman of real estate advisory at KPMG, describes: “I have never seen so much money in my whole career as there is now. Equity is coming from so many diverse sources.”
However, this influx of capital has also changed the environment into which it can be invested.
“At the same time you have new entrants from Asia in particular who are also creating potentially global investment management businesses,
so there is a lot more competition,” Barter adds.
This has had a double impact on the industry. With more money comes more investment companies chasing the same opportunistic investments, and with more investment companies, comes the option for backers to drive down fees and, with them, profit margins.
“So these guys are having to be more innovative and creative,” says Barter. “Fund managers are having to look at other asset classes and in some cases move up the risk curve in order to generate the kind of returns that will appeal to the investors they are hoping to attract.”
More opportunities
Craig Hughes, UK real estate leader at PwC, believes it is not a huge leap for either the private equity businesses, or their investors, to add core-plus to their existing opportunistic strategies.
After all, private equity firms “do understand core assets, as that is what they sell in the end”, he says.
Barter adds: “Core-plus gives a little bit more opportunity for active management, and at this stage in the cycle – certainly in the UK, when recovery is under way with low inflation, low interest rates and a lot of competition – there is a lower supply of the richer opportunity-type deals and these guys make their money from adding value to the properties they buy.”
Some private equity firms, however, have not adopted core-plus as a co-mingled central fund strategy. As Fraser Greenshields, head of real estate finance at EY, says: “There are a few [private equity firms] that we know of that are looking at ways they can do more than just have one product, such as an opportunistic, traditional, closed-ended co-mingled fund. Some are doing that by having core segregated accounts.”
By doing this, firms will able to mix and match deals for investors looking for different returns and over different durations, thus widening the investor pool.
Solutions to the problem
For smaller funds with less manpower at their disposal, their ability to run and subsequently win segregated account mandates is more limited.
In order to get their piece of the pie they are considering listing funds in order to have access to fresh equity through the capital markets.
Barter describes this approach as a search for “evergreen capital” in which investors are attracted to invest longer-term.
“If you create a pool of capital that goes on and on you do not have to go out constantly raising for it. You can take a slightly longer-term view on your returns, and it offers you more opportunities for investment.”
Ares Capital has explored the option of listing a part of the fund in recent months to diversify and compete in the UK market, as has Moorfield.
Longer duration funds or vehicles have advantages for investors too, believes Hughes. “If you are an investor who wants an asset for 20 years, and if the closed-ended fund has a 10-year life and not everyone involved wants to extend, then you could have a problem,” he says.
A solution can sometimes be found through rolling over funds, but only if investors are amenable to the idea.
In creating a listed vehicle, or perhaps creating a segregated account for the same client base, firms are creating another exit to solve the problem. Additionally, private equity firms are opening up their investment skills to those looking to diversify from more traditional partner institutions.
Whether expanding their offering through either a listed vehicle or a segregated mandate, the outcome of doing so by private equity firms adds to the potential investor pool.
Diversification strategies
New investors are attracted to the competitive marketplace by a need for asset diversification.
“When someone has an investment portfolio that covers the globe and covers other asset classes, when they work out their diversification strategies and models it can deliver great benefits for them,” says Hughes.
This search for asset diversity is an ever-present feature of the investment markets, but with historically low interest rates forcing down yields on more traditional assets the appetite for broader strategies is greater than in other years.
“Core-plus offers you far more than if you put your money in a bond or in cash. At the moment returns on real estate, relative to other returns, are huge, even if you go in at a 5% yield. So it is not about absolute returns, it is about relative returns,” says Hughes.
With private equity opportunity funds returning on average 15% in recent years, and core-plus strategies returning only a few percent below that, traditional investors into higher yielding funds are being drawn in.
For EY’s Greenshields, the acceptance of the new strategy has been helped by investors understanding that in the current environment, returns in even the more opportunistic strategies have been pushed down by competition.
But for Hughes it is the proven track record of the teams in their local markets which make the idea of a different investment strategy easier to accept.
“Think of all the expertise and talent that sit within the real estate firms.
Now, just because they generally go and find opportunistic or real value-add opportunities does not mean they haven’t come across core plus opportunities,” he says.
“If that talent isn’t overstretched on the underlying traditional business and there is capacity, why wouldn’t you look at core-plus?”
Size matters
Size, though, is still an issue for the smaller funds. No matter how much talent the fund may have, or how much it diversifies strategies, it will only help attract a certain amount of the capital.
As a result, it is likely the next strategy that will happen in the private equity industry will be the disappearance of smaller funds as they get swallowed up by the mid-sized players.
That way, with a healthy use of alternative strategies and consolidation within the industry,
“There are some fast-growing international players that could be as big as Blackstone one day,” says Barter.
“After all even Blackstone is going to face competition before long.”
