24th November 2015
At Langham Hall, we sense that the issue of ‘permanency’ has climbed up the agenda in European real estate fund structuring. That is to say, there is growing interest in permanent, semi-permanent and longer-dated property vehicles.
Talk of longer-dated funds permeated the Langham Hall Real Estate Fund Structuring Summit we held in October 2015 at our London headquarters. In a first of its kind event for us, we invite 10 leading law firms and Big Four accountants to this council-style meeting to swap intelligence on the market. Mike Sales, global head of real estate at TH Real Estate, also agreed to take part by providing an overview of the European and global market to get us going.
It is abundantly clear that real estate fund managers are operating in an environment of high asset prices in prime European locations combined with increased regulation and operational costs. Linked to this, it was interesting what our London-based guests placed on the agenda. Items included:
• Strategy shift by managers and products investors desire
• Industry consolidation
• Funds v Joint Ventures and Segregated Accounts
• Asian and US capital
• BEPS and fees
These items (and more) received air play, but what seemed to resonate the most was this increasing interest in longer-dated structures. As is so often the case, it isn’t so easy to pinpoint exactly why something is. However, contributing factors at play in the rising interest in ‘permanency’ include the desire among managers for durable fee-earning structures, a struggle to meet target returns and attempts to cater to the needs of investors.
Our participants noted the following: Macfarlanes’ Jagdip Gujral said there had been a rise in interest among managers looking to establish long-dated products in excess of the typical 7 year term of most blind pool real estate funds, including products which have the potential to be evergreen.
“This comes at a time when investors seem to be prioritising income returns rather than capital growth to match their own liabilities and internal return targets,” he said. “We see this as a potential development in the market which is driven in part by a lack of affordable stock particularly in the UK that is limiting the ability of fund managers to meet their target returns. Long-dated products mean there is less pressure on fund managers to sell well performing assets,” he said.
David Ryland of Paul Hastings also reported an increasing interest in vehicles which either have no fixed life or alternatively a long-term fixed life. “These vehicles provide investors a long term exposure to real estate but are also intended to address the complications that can otherwise arise in a fixed life fund where the investment and harvesting period does not necessarily coincide with the market cycle,” he pointed out. Furthermore, he noted how the market was seeing interest in listed real estate as a means of accessing the Defined Contribution Pension and private wealth market and also the burgeoning middle class in the Far East.
Mike Sales of TH Real Estate hinted TH Real Estate had a European core open ended fund on the slate, noting the attraction of not having to constantly return to the market and that in 2007 GPs had lost sight of the fact that real estate is a long-term investment play.
Of course, longer-dated funds tend to get associated with lower returns and a style of property investing focussed on core real estate. As such, managing this kind of vehicle is unappealing to some managers. As Alexander Chester of Clifford Chance remarked, though managers appreciate the benefits of open ended and semi open ended structures, some still find it “conceptually difficult” to live with not earning carry that comes with a classic blind pool time horizon. Furthermore, regulation has led to increased costs of managing a real estate fund and there is also fee pressure coming from investors, so some managers require a higher returning fund to make it worth their while, as Macfarlane’s Alex Amos pointed out.
Still, Chris Luck, partner at Nabarro, said fund duration, exit strategy and related fund terms had all become subject to increased consideration upon a fund launch. Whilst funds will have differing durations according to investor type and strategy, there is preference for a clear strategy on when and how the assets may be sold or investors can exit.
Oliver s’Jacob at Reed Smith made an interesting observation too. Listed REITs are the other solution to the problem, but they also typically trade at a discount to NAV. “We are seeing managers trying to find solutions through unlisted evergreen vehicles with liquidity windows, but if you dig down into the detailed fund terms, as often as not, the liquidity windows are not 100% binding on the manager – a sort of commitment to provide liquidity if they can, but no obligation actually to sell assets and/or wind-up the fund if they cannot.,” he said. “ To my mind that puts investors in a worse position than in a traditional closed-end fund where at least they can usually force a wind-up at the end of the fund’s contracted term if necessary to exit their investment.”
Certain things are worth underlining: Best practice dictates that positions of investors and their managers need to be aligned or at least covered by the fund terms without creating inflexibility. A fund and strategy needs to be able to adapt to changing market conditions so that an asset can be sold at the best time rather than it being forced due to approaching fund termination. A fund also needs to consider extension for those who wish to continue but without locking in investors who do not.
This in part simply reflects the need for communication with investors and roles for an advisory committee or investor votes where appropriate. As ever, talking with investors is the key.
• If you are interested in receiving an extended article following the Langham Hall Real Estate Summit complete with photography, please contact Rob Short at Rob.Short@langhamhall.com
• Our appreciation goes to the following that attended and contributed to the Summit: Antony Grossman at BLP, Oliver s'Jacob from Reed Smith, Chris Luck of Nabarro, David Ryland from Paul Hastings, Richard Johnston of EY, Neal Diplock of PwC, Alex Amos and Jagdip Gujral at Macfarlanes, Alexander Chester from Clifford Chance, and Mike Sales of TH Real Estate