Fundraising for real estate funds continued to lose momentum in the first quarter of 2017. In total, 48 funds held a final close in Q1, raising a collective $18.5 billion – this represents a 37 percent and 48 percent drop, respectively, compared to the same period in 2016. If fundraising continues at this pace, the capital raised in 2017 is likely to be the lowest in any post-financial crisis year.
At the end of Q1 2016, there were 700 funds in market collectively targeting $243.1 billion, while at the end of Q1 2017 there were 677 funds targeting $230.3 billion.
A total $19.5 billion in capital was raised by 42 funds closing in Q1, down 37 percent from the same period last year when $29.3 billion was raised across 73 funds. The total capital raised in Q1 was the lowest for a first quarter since 2012 ($13.3 billion), while the number of funds closing was the lowest since 2010.
Funds with a North American focus accounted for 64 percent of total capital raised in Q1, garnering $12.5 billion. It was the only geographical focus to grow its commitments for the quarter
over the previous year. Capital raised increased 15 percent, while the number of funds closing fell 22 percent.
Opportunistic real estate funds in market have replaced value-added fundraising as the top strategy in market since Q2 2016, representing 30 percent of targeted capital. Despite this, value added funds account for the largest portion of funds in market at 37 percent. The amount of targeted capital for secondaries funds grew by 63 percent from last year, due in large part to Landmark Real Estate Partners VIII, which is targeting $2 billion.
A pullback is likely a sign that fundraising has reaching its peak for this market cycle. “After returning record amount to investors in the 2013-2015 period, fundraising gained momentum and dry powder is now at an historical high,” says Bronwyn Bailey, vice president of research and investor relations at the AIC. “At this point, fund managers are focused on how to put that capital to work by investing in deals. The challenge for them is current high valuation levels, which dampen deal flow.”
New capital flowing into the sector has been tempered by a number of factors, including greater caution in the marketplace due to the late stage of the real estate cycle. Other contributing factors to that pullback in fundraising included uncertainty around the outcome of the U.S. presidential election, restrictions on capital flows out of the country enacted by the Chinese government, as well as some large funds that closed in 2015.
The overarching mood among institutional investors and pension funds is to be cautious, selective and patient. Those sentiments are rippling through the marketplace and showed up in actual capital raise in 2016 and expectations for 2017, as well as in asset pricing, notes McMenomy.
That caution is also influencing investment strategy. “As the real estate market completes a full recovery, we believe that successful investment strategy going forward will entail dialing down risk through careful market and project selection; increasing the use of structured investments such as mezzanine debt or preferred equity to protect against cost increases; and focusing on existing assets with solid cash flows,” says Ciganik.
One sector where there is still sees a lot of opportunity is the single-family rental sector. While commercial real estate in key markets has fully recovered and is now about 30 percent above its pre-crisis valuation peak, single-family home values are still below the peak and only about three-fourths of the way back to where they should be on a long-term trend supported by income and affordability levels, notes Ciganik.
Although the dip in fundraising is modest, it is certainly enough to be felt in the private equity marketplace. According to Preqin, the fundraising market remains highly competitive for the 525 fund managers currently on the road in January 2017 that were seeking a combined $177 billion.
The decline in new capital coming in may exacerbate the challenge for new managers and smaller funds to attract capital. There is already a big gap in the private equity market between the “haves” and “have-nots.” The majority of capital is flowing to the top funds and fund managers, and the broader trend in the industry to consolidate the number of manager relationships has only contributed to that growing bifurcation.
Despite predictions of a further decline in fundraising in 2017, there are also some factors that could bode well for more capital flowing into the sector this year. For example, the U.S. remains an attractive target for foreign investors. “Although it is late in the cycle, the U.S. real estate market seems stronger than most of its developed market peers, with positive economic fundamentals and demographics providing a tailwind,” says Ciganik.
If your thinking about raising capital for your real estate fund call us and lets talk about your fund. John Denes