The middle ground is noticeably absent as core funds and distressed strategies continue to attract the capital. Shayla Walmsley reports

It has been an interesting start to 2012 in the real estate fund capital raising markets. While private equity giant Blackstone has caught the headlines with its ability to revive the global ‘mega-fund' model, smaller managers have been gaining traction with smaller, targeted core funds.

In January, Fosca II, a joint venture between OFI REIM and F&C REIT closed with €197m raised from pension funds and insurers from countries including Finland, the UK and the Netherlands. The closed-ended fund, which has a target size of €400m, invests in offices in the Paris central business district (CBD).

"The French economy is dominated by the public sector, and they are in recession-denial. It seems odd but it works," says Iain Reichwald, director of property finance and operations at F&C REIT.

The fund may also target French regional markets, although at least 70% of the fund's assets will be in central Paris. "Our view is that the French market means Paris," Reichwald says. "There is no real prime outside the capital."

A characteristic of the new generation of core funds - apart from their modest size - is their specificity. The second closing in January of Henderson's €350m German Retail Income Fund raised €90m from 12 investors, mostly German insurers and occupational pension schemes. The core/core-plus Spezialfond will eventually hold 10-15 assets. Henderson's fund is not targeting the German retail sector but more specifically supermarket-anchored retail warehouses.

Fosca II has a similarly tight focus, targeting Le Defense for its CBD-like characteristics. The buildings tend to be traditional, in the style of Baron Haussmann, which fits occupier demand for traditional conversions. "Tenants prefer quaint buildings to clustered skyscrapers," says Reichwald.

That said, M&G Investments' UK long-lease core fund is by no means small. The M&G Secured Property Income Fund raised an extra £433m (€516.1m) from UK pension funds in 2011, enabling it to acquire seven assets during the year, increasing its size to approximately £1bn. M&G Investments claimed Dutch pension funds were also interested in the fund due to the lack of a Dutch government index-linked bond market.

In the meantime, it seems there has been little decline in investors' appetite for debt funds. According to data firm Preqin, 28% of the capital raised last year for private equity real estate investment was for debt-dedicated funds (leaving aside those with a debt component), compared with 17% for opportunistic strategies. In fact, the four largest funds to close last year used some degree of debt.

Although they are looking to exploit prime locations, debt managers are often specialists rather than large fund management houses. Aeriance Investments, for example, launched a £100m fund focused on short-term loans for transactions on prime London residential with an average maturity of 2-3 years. The fund, OREL, which the fund manager believes could double in size, is targeting an annual yield of 10-12%. But the unleveraged fund aims to attract pension funds with the promise of regular income and risk-adjusted returns.

Developers are currently struggling to secure lending above 55-60% of funding costs from banks. "The timing is designed to take advantage of the dislocation in the UK residential property lending market because of restricted liquidity from financial institutions," says Daniel Bendavid, senior investment officer at Aeriance. "Since the fund is focused on lending, our position in the capital structure would still be protected even in the case of a strong market movement."

Meanwhile, Blackstone has raised $6bn (€4.5bn) for a fund primarily targeting distressed assets that is expected to close later this year. Although the group will not comment on the progress of its capital raising - nor on speculation that the vehicle could eventually rival its $10.9bn predecessor - a close source said it had taken six months to raise the capital from repeat investors.

But the market is also seeing niche operators enter the sub-sector. In January, Related Companies closed its first distressed real estate fund with equity commitments of $825m raised from investors including European pension schemes.

The fund targets distressed loans originated for development and renovation, with some room for allocation to equity positions in assets in need of repositioning.

"The strategy is pretty far from core initially but we aim to turn them into core assets quickly - with a discount," says Just Metz, managing principal at Related Fund Management.

The ability to source assets will be an important theme for fall funds, whether they pursue core, distressed and or debt strategies. Reichwald says investors in Fosca II want their capital deployed within 12 months, hence the ability to source assets and transact quickly will be critical. "The guys on the ground have to be ahead," he says. "It takes six months to find an asset, three months to do the deal. You need a manager who can shorten the transaction time."

Metz says a credible fund manager, from an investor's perspective, is one who can deploy capital quickly. "There aren't thousands of these assets out there," he says. "You have to work market by market, researching the assets, tracking down the owners and debt holders, then making the deal." He estimates it will take 24-30 months to deploy the capital raised for its distressed property fund.

German fund manager Corestate launched its German Commercial Properties Fund prior to the financial crisis. The investment manager has evidently shown its ability to carry out its value-add and opportunistic investment strategy, having attracted new money from a large Finnish financial institution. The new equity means it now has roughly €400m to invest in office and retail properties in Germany, Switzerland and Austria, through direct investments and distressed situations, including preferred equity and mezzanine investments.

Fellow German manager SEB Asset Management has launched an income-oriented pan-Asian fund targeting German institutional investors with a €20m minimum investment requirement. The fund, which has a target annual 8% yield, will allow gearing of up to 50% and the potential to allocate some portion of the capital raised to forward-funding development projects.