The job of investing capital is becoming increasingly challenging for non-listed funds, all the more so the further up the risk curve we look. Jeff Rupp reports

European non-listed real estate funds found it increasingly difficult to invest capital in 2007, according to the INREV Capital Raising Survey 2008. The survey, which gives an overview of the capital raising trends of non-listed real estate funds, showed that in 2007 the market absorbed equity equivalent to 69% of the capital it raised in the same year, which is a dramatic fall from the 84% absorbed in 2006 and 90% invested in 2005.
"If you look at the numbers for 2003-07 in absolute terms, the amount of equity called in is at an all-time high, but that is against a backdrop of a much higher amount of capital raised, so there has actually been a decline in the ratio," comments Asli Ball, a member of INREV's research committee and vice-president of GIC Real Estate in London.
The INREV Capital Raising Survey was based on the responses of 85 funds and 15 funds of funds that provided data on the capital they raised and called in during the period from 2003 to 2007.
Two distinct trends emerged in the analysis of the survey results for last year, according to INREV research director Andrea Carpenter: "The strong competition for real estate investments in the first half of 2007 that drove yields down to historical lows in many markets was seen as a major obstacle to funds finding investments that could deliver the targeted returns for their committed capital," she explains.
"But in the second half of the year, as the credit crunch began to emerge, rising yields made prices begin to look more attractive, but the increase in market uncertainty and the rising cost of debt, especially for opportunity funds, created a difficult environment for investing in real estate."
Core property investments were the leading target for funds raised in 2007, with 47% of the capital directed at that strategy, while 29% of the capital raised within the opportunity investment style and 24% targeted at value added.
The ability for the non-listed property funds market to absorb the capital also varied by style with opportunity funds finding it the most challenging investing environment in 2007. This investment style raised the highest level of capital in 2007 but these rising volumes could be explained by the fact that these funds have become more attractive as active asset management and new emerging markets/sectors have become the only areas to achieve higher returns with income growth starting to become the sole driver of total returns as yields bottomed out.
However, a low absorption rate of 23% in 2007 indicates that the high levels of capital raised by opportunity funds in 2007 have also been much more difficult to invest due to the turbulence in the financial markets and the lack of availability of debt. This compares with raising to call in ratios of 91.5% for core and 79.6% for value added.
Funds of funds, which were analysed separately to avoid double counting with the non-listed funds they invest in, also seemed to have an especially difficult time investing the capital they raised in 2007. The 15 funds of funds included in the survey raised €2.7bn, but only called in €1.1bn for investment last year.
This struggle to keep up with the pace of growth demonstrates that the funds of funds sector is in a phase which is focused on establishing vehicles rather than committing capital to underlying target funds. They remain bullish for 2008 with some 80% indicating that they would continue to raise capital in 2008, of which three-quarters said that they would raise more this year than last year.
Despite the onset of the credit crisis in the summer of last year and the difficulty absorbing equity, funds' capital raising targets remain high for 2008, with 68% of those planning to raise capital this year expecting to raise more than they did in 2007. This figure does not account for new funds which will also come to the market in 2008.
 Georg Allendorf, managing director at RREEF Alternatives in Germany and a member of INREV's management board, says he believes the continued optimism over capital raising this year stems mainly from two factors: "First, European pension funds still want to raise their asset allocation to real estate to a target of about 10% of their investment portfolios from an average position now of one or two percentage points below that. Second, inflation expectations are rising and in this type of environment investors favour real estate's inflation hedging characteristics."
He adds: "Most European real estate markets have already seen some downward correction in values, so some investors are actually considering increasing allocations to take advantage of the correction rather than turning their backs on the asset class."
 "In any case, we see investors continuing the trend of switching allocations from direct property to non-listed real estate funds even with the more challenging market. Furthermore, the survey seems to show that in this time of turbulent markets, higher yielding real estate funds tend to be favoured. Such funds are more able to actively manage their way through the uncertainty compared with more traditional funds that rely more on the market as a whole," he explained.
Of the 85 funds that responded to the survey, 41 raised equity in 2007. The total amount they raised was €8.6bn, while only €5.9bn was called in. Pension funds and life insurance companies continue to be the most active investor groups, but funds of funds expanded their activities and accounted for 13.9% of the capital raised. For the first time, high-net-worth individuals were listed separately in the survey. They represented 6.2% of the amount raised in 2007.
Even though the euro was relatively strong in 2007, the US and Canada, which were reported together, were the largest single source of capital investing in European non-listed real estate funds last year, as they were the year before. This result was partly due to a number of opportunistic funds that raised large amounts of capital in the US being included in the survey sample, however.
After the US and Canada, the UK, the Netherlands, Germany and the Nordic countries were the largest sources of capital raised, although non-European investors such as Asia Pacific and the Middle East were also represented.
In terms of allocations, the Netherlands was the single largest target market for capital raised, while the Nordic countries, Germany, France and the UK followed in popularity. By sector, retail and office continue to dominate the allocations, with retail taking almost one-third of the allocations at 32%. Somewhat surprisingly due to the perception that the sector is at the top of the market, residential also figured strongly at 19.6%, although this figure could reflect a move toward distressed sales.
For funds of funds, the UK was the main source of capital raised in 2007, representing 38% of the €2.1bn total, followed by the Netherlands with 26%. Asia represented 19% of the capital raised by funds of funds last year. Some 43% of the funds of funds that responded to the survey have some target allocations in Asia, indicating that capital from European investors is gaining access to the Asian market through funds of funds.
Jeff Rupp is a senior consultant at Bellier Financial in Amsterdam