Can listed companies that sponsor private funds maintain an alignment of interests with both sets of investors? Shayla Walmsley investigates
Prologis, Blackstone, KKR and Apollo - all listed companies, some REITs - sponsor private funds. You can see why. Funds allow them to finance acquisitions and development projects, create economies of scale, and develop partnerships with institutional investors. Above all, they diversify income via comparatively stable management fees.
But for one private equity firm partner, speaking anonymously, the last point is the problem. Assets equal income for the parent, but for the fund manager it should come from fees. These are two different models and could create conflict of interest.
"By going public, Blackstone has changed the incentive. Before, it was alignment with investors in their funds. That's no longer the case," he says.
Yet according to Guy Jaquier, CEO of Prologis Private Capital, it makes no sense to see a potential divergence of interest between shareholders in a REIT and limited partners in a private fund. "Both are looking to make a total return. That is not a divergence of interest," he says.
"If you are a shareholder in Prologis, you're investing effectively in different countries with different risk and return profiles," he says. "We own core assets in the US and Europe, and we're developing properties in Brazil and Japan. When you invest in a fund, you're investing in the strategy of that fund."
Less critical voices have pointed to the hybrid nature of REIT-sponsored private funds, without necessarily coming to the same conclusions. Cervantes Lee, at CBRE Hong Kong, pointed to some of the issues back in 2008, when he was at MIT. Lee suggested that once a REIT sets up a private capital business (or, presumably, vice versa), it turns into a combination of both public and private real estate.
The problem for the unnamed private equity partner is the requirement for the REIT parent to demonstrate earnings velocity to shareholders, which potentially creates an incentive to gather assets in the same way that banks did in the run-up to the financial crisis - and which led to them having to spin off their high-risk real estate units.
"These companies don't belong in the stock market. They are there because of the greed of their owners," Lee says, pointing to the low multiple assigned by the stock market to performance fees in comparison with investment management fees. "There is an inherent bias towards becoming assets-under-management aggregators rather than relying on performance fees."
But that is to assume that REITs are, in fact, accumulating assets. Prologis does not want to be an asset aggregator, according to Jacquier. "In reality, we recycle assets as well. In fact, we're a major seller," he says.
This potential divergence of interest could be the least of listed companies' problems. The unnamed private equity partner compares latter-day REITs such as Blackstone with the likes of Morgan Stanley real estate funds in the 1990s: "Too big - and motivated by earnings pressure." Morgan Stanley's MSREF VII fund became a byword for post-bubble hubris. The fund manager was forced to cut the size of the fund and ask investors for an 18-month extension (it got 12) on its deadline to deploy capital after it invested less than half of the $4.7bn (€3.8bn) committed. Sovereign wealth funds GIC and CIC, and Canadian pension fund manager CPPIB, are among the fund's largest investors.
"Blackstone looks as though it's doing the same thing," says the partner. The private equity giant earlier this year raised $16bn for a so-called mega-fund it started marketing last January. "Apollo and KKR are under the same pressure."
Blackstone did not respond to requests for comment. A spokesman for the $105bn Apollo Global said it "doesn't really fit the bill" (it is not a REIT, and it invests in alternatives other than real estate). Apollo's Q2 data show management fees increased from $35m a year ago to $156m (as a result of fundraising), and its assets under management increased 46% during the same period to $105bn.
In any case, it is worth pointing out two caveats about private equity funds sponsored by listed companies. The first is that it is hardly surprising that funds specialising in distress should be particularly active today. If ever there were a time to accumulate assets, it is probably now.
The second is that there is investor appetite for these funds. The Teachers Retirement Fund of Texas is among the major US public pension schemes to commit capital to private equity funds managed by KKR and Apollo.
You can see why investors might elect to commit capital to a fund sponsored by a known parent. Asked to explain why Prologis' larger shareholders have invested in its private funds, Jaquier says: "Imagine you're the underwriting manager responsible for private capital real estate investments. You do the analysis and you come up with a choice of three general partners (GPs). When you take it to the board for approval, it helps that one of those GPs is in the public eye already, vetted and subject to governance and transparency rules that go with listing. If the other side of your house has elected to own 3% of the stock, it's a more comfortable proposition."
For the private equity partner, part of the blame for perilous accumulation lies with investors in the funds, rather than exclusively with fund managers. "No one ever got fired for investing in a Blackstone fund," he says. "Everyone talks about what the GPs did [in the run-up to the financial crisis], but the truth is an equal amount of blame should go to the limited partners."
Despite some overlap, Jaquier points out that investors are constrained by their own rules. "If they invest in the stock, they gain exposure to a basket of opportunities across four continents, along with the expertise of the GP," he says. "Private capital is a targeted investment - say, core US or development in Brazil. We're talking about different investors - or at least different buckets."