Some in the real estate industry are forecasting a second wave of consolidation. But will it be different from the first wave and how will it affect investors? Shayla Walmsley reports

If there is to be a second wave of pre-crisis consolidation in the real estate fund management industry, one thing is almost certain: it will not look like the first.

A new wave could take the form of US fund managers seeking to acquire wholesale European investor bases. Hermann Aukamp, CIO and director of real estate investments at German pension fund Nordrheinische Ärzteversorgung (NAEV), points to the recent interest shown by US fund managers in RREEF Real Estate.

In the end, advanced talks between Guggenheim and owner Deutsche Bank collapsed as they were unable to agree terms. But could we see successive examples of US real estate firms seeking to acquire German enterprises? Aukamp stresses the importance of differentiating those that covet German platforms in order to establish an existing investor base with those simply looking to get hold of real estate assets. The former are likely to be mid-sized companies looking to establish a business in Europe.

However, rather than a repeat of the first ‘wave’, which included large mergers such as ING Real Estate Investment Management/CBRE Global Investors and AMB/Prologis, the next stage could end up fitting the description ‘attrition’.

One UK-based fund manager, speaking off the record, thinks this is likely. With the most attractive targets already accounted for, it could be that many of the remaining fund managers unable to raise capital will simply go under. The manager cites a relatively small mainland European fund manager currently touting itself to buyers around Europe, but which has so far been unable to find a suitor.

The second wave could generate less of a bang and more of a whimper. According to Stefan Pfister, head of advisory at KPMG Switzerland, the second wave will not target specific markets. “The first wave happened everywhere. Now it will just be single cases,” he says. 

In contrast, Antonio Alvarez, head of investments, property multi-manager, at Aberdeen Asset Management, believes consolidation could eventually take between 20% and 30% of fund managers – but the process will take a while. “Boutique managers with two funds, and small managers with funds coming to the end of their lives, will be totally stuck,” he says. “They’ll either disappear or be bought out. When a fund manager comes to investors wanting to extend the fund by two years, the question for investors is whether the market will be any better [in two years’ time].”

A lot hangs on the macro-economic backdrop. A recovery could bode well for struggling managers. Perhaps a continuation of the economic slump and uncertainty will play into the hands of those looking to make acquisitions.

The problem for many troubled fund management companies is that even a moderate economic upturn, which would have helped sustain some funds for a while longer, has proved elusive. As Alvarez points out, some end-investors have, up to now, been willing to give funds a couple more years on the assumption that the market was bottoming out. Now it looks as though the market is to stay at its current level for some time. Some investors requiring liquidity will, in any case, be looking to withdraw their capital.

“The market is going sideways and, as I’ve been telling everyone, sideways is dangerous for funds. People don’t see the recovery, so they will consider divesting or, in the case of open-ended and semi-open-ended funds, seeking redemptions,” he says. “Many investors now see no prospect of the market getting better and the banking sector is still a shambles. Some investors have lost hope and they want to pull out.”

Fire sales benefit neither managers nor end-investors. “Some managers have been postponing the liquidation of the portfolios and therefore putting investors in a difficult position as they face either approving the extension of the fund’s life or facing a fire sale that will destroy a lot of value,” says Alvarez. “Of course, part of the blame for this is the state of the market but, at the same time, I would point out that it is almost rare to see a manager with a well-defined disposal plan for the portfolio, even as the fund approaches the end of its life.”

He adds: “It’s a fine line. Up to now, investors have largely voted to extend funds. There is limited room for negotiation without redrafting the terms of the fund. At the same time, if investors force the manager to liquidate the portfolio, a fire sale benefits no one.”
When IP Real Estate conducted a straw poll last May at its Investor Forum in London, it found significant support for boutique fund managers implied by 62% opposing further consolidation. Now, many of the same kinds of investors – pension funds and insurers – are relatively sanguine about the prospects for what will amount, after all, to them having fewer investment options.

Overall, for example, Aukamp believes the impact of US fund managers acquiring struggling European ones will be neutral for pension funds such as his. “Investors still have a choice,” he says. “Even if a US company owns the operation, more competition between European managers will always be good for investors – especially if it’s a choice between better-funded asset managers.”

A PwC paper in 2010 likened the real estate fund management industry to ammonites facing the Permian-Triassic extinction event. The threat of imminent demise has at least concentrated fund managers’ minds.

You could argue, as does PwC partner John Forbes, that the second wave of consolidation will simply be an extension of the first. “I don’t see this as a second phase of consolidation. I think that it is an ongoing trend,” he says.

Yet he draws a distinction between “failing organisations throwing in the towel” and consolidation as a positive step on the part of the fund manager aimed at becoming more efficient. Sellers will partly be driven by the regulatory framework within European markets, notably the costs associated with Solvency II and the Alternative Investment Fund Managers Directive (AIFMD).

“In the current environment, real estate investment managers need to become leaner,” Forbes says. This could mean outsourcing within tax and regulatory constraints. But it could equally entail a shift towards a new business model characterised by sharing of business infrastructures. “Traditional consolidation to generate cost savings is an option, but it is not the only one,” he says.

In the same vein, Paul Jayasingha, senior investment consultant at Towers Watson, believes the need to become more efficient might result in consolidation but, equally, it might not. “Fund managers across asset classes need to control costs and become more efficient,” he says. “One way to do this is through gaining economies of scale through mergers. But mergers tend to raise lots of short-term uncertainty, and economies of scale may be limited for certain real estate strategies compared with equity and bond strategies.”

Either way, fund managers will continue to face pressure on fees (and margins). “Up to now there has been this feeling that lower quality managers have needed to adjust their fees but higher quality managers haven’t. That isn’t true. We expect fees to come down across the board,” says Jayasingha.

“There has already been some movement in fees, from very high levels to just high levels. But in a low-return environment, we think the average level of total fee is still disproportionately high . In a more low-return environment, fund managers have to be more cognisant.”

If fee adjustment is one implication, another is more and better communication between fund managers and end-investors, according to Jonathan Cantor, partner at Nabarro.
“I hope the fund model returns to how it was before 2007 when more funds were being closed,” he says.

“But the balance of power is a product of the market. In the past three or four years there has been more co-operation between managers and investors. On the other hand, lessons have been learned and there have been improvements in governance, transparency and communication – all of which are good for the industry as a whole. I don’t see that changing.”