WSJ Reports Real-Estate Funds Have a Problem: Too Much Cash
March 27, 2019 | James Sprow | Blue Vault
As deadlines approach for spending investor money, fund managers face challenges finding profitable buildings to buy. A story in the Wall Street Journal on March 26, 2019, describes how private equity fund managers are sitting on record amounts of cash and finding it increasingly difficult to find investments that meet the expectations for returns that they have created for their investors. These funds have made promises to their investors to acquire real estate portfolios within three to five years. However, in June 2018, closed-end real estate funds that were launched in 2013 and 2014 still had $24.8 billion in dry powder, according to Peqin Ltd.
The article stated that the unallocated capital problem is likely to get worse. The total amount of dry powder held by closed-end private property funds increased to a record $333 billion this month, up from $134 billion at the end of 2012, according to Preqin.
In a 2018 survey, 68% of real-estate fund managers told Preqin that it was more difficult to find attractive investments than it had been a year before.
One decade into a bull market for commercial real estate, it has become much harder for firms to hit their return objectives. “Finding profitable buildings to buy has become more challenging amid fierce competition, slowing rent growth, and fears that the real-estate market is heading for a downturn.”
When a private equity real estate fund misses deadlines it means either going back to investors and requesting an extension or being forced to return their money. Their client investors then find it more difficult to meet their return objectives.
Some private-equity firms are being forced to make course corrections in their investment strategy to meet their deadlines. Larger firms like Blackstone and Brookfield that have raised $20 billion and $15 billion for their property funds, respectively, may find it easier to meet their deadlines because they can buy entire companies or portfolios, unlike smaller funds that deal in single, smaller acquisitions. According to Brookfield’s Brian Kingston, Brookfield’s scale enables it to get returns “you simply can’t get if you’re an individual investor buying an individual mall.”
The strategies used by these funds can change to meet the challenges of putting their capital to work. One strategy is to use less debt to leverage their investments, making it possible to place more equity per deal. Another is to seek extensions from investors to allow more time to place their funds. A third approach is to reduce the size of their offerings.
Does the record amount of dry powder on the sidelines indicate greater demand and rising prices for commercial real estate going forward? At some point, these funds with $333 billion in cash will have to either invest it or go back to their investors and ask for more time to place the funds, which may only kick the proverbial can down the road.
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