Does fundraising slowdown mark a turning point for real estate markets?

Capital raising for real estate funds slowed last year, according to data provider Preqin. Does it mark a turning point in real estate’s bull run?

While the $109bn (€90.9bn) raised for private real estate funds last year is down on 2016’s $126bn, it is still relatively high and means 2017 was the fifth consecutive year for real estate funds to raise more than $100bn. Preqin also says the figure could be revised up by up to 10% once more information comes through.

But investors should not dismiss the findings. Most crucially, the slowdown in real estate comes at a time when other private-market funds – such as buyout funds, debt funds and infrastructure funds – have had record years.

“The private real estate market is currently running in counterpoint to the wider private capital industry,” says Oliver Senchal, head of real estate products at Preqin. “These could be signs of growing sentiment that the market is at risk of becoming overheated… If investors are seeking to protect themselves from a turn in the market, we may see this trend continue and strengthen into 2018.”

Capital Economics, a consultancy, has warned that Preqin’s numbers could form part of a growing body of evidence of “the start of a change in the market”.

In a note released today, Kiran Raichura, senior European property economist at Capital Economics, picks up on the fact that real estate fundraising has bucked the trend in the wider private markets, but he also points to the increase in proportion of real estate funds not reaching their capital-raising targets.

Nearly half (47%) of real estate fund managers did not reach their targets in 2017 – up from 41% in 2016 and the highest proportion in five years. Raichura says this suggests managers are “struggling to convince clients to part with their money to invest into a market in which pricing is looking increasingly stretched”.

He connects Preqin’s findings to difficulties experienced by recent initial public offerings (IPOs) of European real estate investment trusts (REITs). Aberdeen Standard Investments’ European Logistics Income REIT – which made its first investment this week – missed its fundraising target by 25% in December, while other REIT IPOs around that time were scrapped or postponed, including M7 Multi-Let REIT and Aviva Secure Income REIT, with the latter citing “insufficient demand”.

Cromwell Property Group’s attempts to list a European property fund on the Singapore stock exchange was similarly protracted and required reducing its IPO to see it through.

Raichura says the “final cause for concern” is Preqin’s finding that, while fundraising levels have dropped, the number of funds (574) seeking to raise capital – and the volume of capital ($191bn) they are targeting – has hit a record.

This suggests too much supply (prospective funds) and too little demand (from investors). But Raichura also points out that, when combined with dwindling return expectations for real estate, it could turn out to be a disappointing year for capital markets.

“The amount of capital being raised tends to rise in line with recent performance,” he says. “Given that we think property returns will soften this year, there is a risk that the targets that funds are advertising will not be achieved. As a result, return targets and investor expectations may need tempering in due course. Growing concerns at stretched valuations, as well as limited prime stock, point to a fall in investment in 2018, for the first time since 2009.”

However, the picture for real estate fundraising in 2017 is not uniform. While the more conservative (core and core-plus) and high-return (opportunistic) ends of the spectrum saw a fall in fundraising, the middle ground (value-added) actually experienced a rise.

So too have real estate debt funds, which had a record year, raising $28bn. Preqin says this is indicative of investors becoming more wary of a market correction – both value-add and debt strategies are arguably better suited to an environment of rising interest rates and property yields. “There certainly does seem to be a rebalancing of activity between various strategies, which perhaps indicates that investors are looking increasingly for downside risk protection,” says Senchal.

In an earlier report, in November, Preqin showed that appetite for property debt strategies had surged over the past two years. The share of investor searches for funds and mandates that include real estate debt more than doubled to 27% of all searches in the third quarter of 2017 – from 13% in the third quarter of 2015.

This could continue as returns for (equity) real estate investments continue to moderate. “Pricing in today’s market is weighing on income returns,” according to a report by investment manager PGIM Real Estate. It notes that “capital is starting to target markets that can offer more attractive yields and stronger growth potential”.

TH Real Estate recently described debt is an investment “superfood”. In a recent research note the investor argues that adding debt to a real estate equity portfolio “at this point in the real estate cycle, which is arguably mature, and holding it through a cyclical downturn, can enhance both risk-adjusted and higher absolute total returns”.