Euro concerns and perceived better prospects elsewhere are hindering foreign investor interest in European product, says Christine Senior
Fund managers have an uphill task in persuading investors to part with their cash. Where managers are attracting investors is at the more conservative end of the risk spectrum as investors pull back to the safety of core real estate investments.
Two surveys from INREV and Preqin illustrate the severity of the situation. INREV's survey in the spring showed capital raised in 2009 fell to €5.9bn from €14.8bn in 2008 and estimated the total expected to be raised in 2010 to be €10.9bn, still well below the 2008 figure.
Preqin's survey in July added to the doom and gloom, revealing fundraising by 20 private equity real estate funds had fallen to $7.3bn (€5.5bn) in Q2 this year, the lowest figure since 2004. Underlining just how tough the fundraising climate is, Preqin found that it was taking longer to close funds. In 2010 managers are taking 19.7 months to close a fund, compared with just 9.8 months in 2006.
Other bad news for funds focusing on Europe is that they were the laggards in volume of capital raised. Of the 20 private equity real estate funds that closed in Q2 this year, five focusing mainly on Europe raised just $700m, compared with four focusing on Asia and the rest of the world raising $1.2bn, and 11 focusing on North America raising $5.4bn.
Yet beyond these solemn statistics it is clear the picture is more nuanced. Invesco reports a bumper year for fund raising: it has already raised around three times more capital this year than it had raised in a single year before.
Invesco's managing director for Europe, Andy Rofe, attributes this success to two factors - the stability of the company and its product range. Three-quarters of Invesco's products operate in the core space. "The flight to quality and increased core allocation in portfolios are playing into our hands."
Although core funds may be investors' first preference, some that are further along the risk spectrum are still successfully raising capital, even if it is taking longer. Axa REIM has just announced the first close of an opportunistic fund focusing on development across Europe, having raised €230m from four European investors alongside co-investment from the group's insurance companies. AXA also reports strong interest from investors for its second closing which is due in September.
But Kiran Patel, Axa REIM's global head of business development, distribution, research and strategy, admits that fund raising has been slow. "Investors are quite rightly more thorough in their due diligence, paying closer attention to risk management areas. It's something they have always done but now they are being more in-depth in their approach. That takes time."
Continuing interest in more opportunistic strategies is a theme highlighted by Rob Wilkinson, managing director, head of European fund management and separate accounts at AEW. He says some investors see possibilities at the other end of the risk spectrum from the preferred core strategies. "It is definitely the case today investors are very focused on core," he says.
"There is though a reasonably substantial part of the market that is taking a slightly contrary view to that and saying: well if everyone is looking at that kind of strategy, maybe there are some interesting things to do at the other end of the spectrum. That's driven a lot by the perception there might be some mispricing in the market. There might be some distressed situations that can favour that kind of strategy."
But the bulk of the funds that are attracting capital are firmly anchored in core, and in funds showing a broad diversification among sectors and geographies. Diversification is key. Broad-based pan-European funds have the strongest appeal for investors.
AEW is hoping to raise €300m-plus initially for its new core diversified pan-European fund. Wilkinson reports strong interest from a diverse investor base. "Before we might have targeted European investors only," he says. "Here there is interest from all regions - Asia, the US, the Middle East as well as Europe. It would surprise me if we didn't have a wider spread of investors than we have seen in the past."
New sources of capital into new funds is something of a rarity in the current climate. Investors with further capital to invest are only willing to trust those managers they already know and have had a good experience with before. Albert Yang, director of institutional business at Henderson Global Investors, says: "I'd be interested to see what percentage of those funds closed are new money into new funds from new investors. I think that would be very low. People are going to relations they already know, with established businesses."
As Preqin's survey shows, funds investing in Europe also seem to be at a disadvantage in attracting capital compared with funds focusing on other regions regarded as having better growth prospects and fewer negative factors. For US investors considering investing in Europe one factor that is holding them back is the perceived uncertainty surrounding the euro, according to Trish Barrigan, senior partner at Benson Elliot. Its value-add fund Partners III, which has a pan-European focus in all types of property, closed in 2009.
"The single most important factor for investors today is the future stability of the euro and their outlook on what is going to happen in the euro-zone. In private equity real estate there has historically been a predominance of US investors who are dollar denominated. The concern for these investors is whether or not the euro will survive or how it might be reshaped if they are investing in euro-denominated or Europe-only funds."
Allied to this concern is a view that there are better opportunities elsewhere. Asia is regarded as a high-growth area, and the US - when it eventually returns to higher growth - is likely to beat growth in Europe, as it has done historically, according to Barrigan. "Not all US investors are required to have a portfolio allocation that includes investment in Europe," she says. "They see opportunities in the US as better than Europe today so they would choose to allocate funds they have for property investment into the US where there is greater opportunity and they don't have any currency risk."
Another negative for Europe is the uncertainty from upcoming European legislation. The effects of Solvency II on insurance companies, and potentially also on pension funds, is a concern, as well as the what will be the impacts of the European directive on alternative investments. "The Solvency II initiative is not a clear picture at the moment, but funds with significant leverage may well suffer from being penalised from equity having to be allocated against that by insurance companies," says Wilkinson.
First closes of funds are proving particularly tough in the current climate. Investors are reluctant to commit to them, even though these initial investors have greater power to negotiate more attractive terms and fees. The result is that first closes are taking longer than before to achieve. "There is a real aversion to being in the first close," says Yang. "That is actually a strategic sea change for some investors. There is fear that the fund may not close or may not be launched, so they don't want to do a lot of due diligence on a fund where they may end up being the only investor or one of a limited pool."
A lack of suitable products is also hindering capital from entering the market. With funds taking longer to raise capital, if funds do not close in 2010, supply of products is likely to be hit. Lonneke Löwik, director of research and market information at INREV, is guardedly optimistic that the fundraising environment is improving, in the wake of a market pick-up. "The first six months of this year some capital was being raised, more than last year," she says. "There are signs the worst is over, though I'm not saying things are looking bright and sunny. But people are getting their confidence back slightly in real estate."