US NEWS: Inclusive ambition

Lone Star sees its second real estate mega-fund exceed expectations as it works with its existing LPs to accommodate some delayed commitments. PERE Magazine July/August 2011 issue.

With the recent closing of its mega-fund over its hard cap, Lone Star Funds is showing that a great deal of ambition met with a modicum of patience can really pay off. At the end of May, the Dallas-based private equity giant, led by John Grayken, closed its second real estate fund at $5.5 billion. Not only is this one of the most ambitious real estate fundraising efforts the sector has seen since the global credit crisis, but the closing is well above its $5 billion cap.

Lone Star Real Estate II, which focuses on commercial real estate investments, received the bulk of its commitments over the past few months, as it had collected just $1.8 billion as of February. In fact, just one month before closing, the fund had $4.2 billion in commitments, meaning it managed to raise $1.3 billion over the last 30 days.

The surge in commitments, however, wasn’t the result of a last-minute rush of investors, according to one source familiar with the situation. Rather, it was due to a number of large institutions needing time to complete the regulatory – and sometimes political – processes necessary to participate in such funds. Since Lone Star did not want to exclude these institutions, especially since they had done a great deal of legwork to participate, the firm requested that existing investors in the fund raise the hard cap from $5 billion to $5.5 billion. Also not wanting to leave these potential investors out, the LPs agreed.

Also helping its fundraising efforts, Lone Star added some LP-friendly terms on the real estate fund, including reducing its carried interest from 30 percent in prior funds to 20 percent. During the investment period, management fees are 1.2 percent based on committed capital, with step-downs for larger commitments. Investors committing at least $100 million will receive a 1.1 percent fee; $150 million commitments pay roughly a 1 percent fee; and $300 million commitments are charged a 0.9 percent fee.

With the fund now closed and having exceeded its target, Lone Star will work with banks and other financial institutions that wish to “shed their commercial real estate exposure,” according to a due diligence report from The Townsend Group, an advisor to the Connecticut Retirement Plans and Trust Fund, which was considering a commitment to the fund earlier this year. Lone Star has made some recent investments, but the source was unsure if these investments were completed with capital from the fund.

The fundraising effort of Lone Star is perhaps all the more impressive given the firm is also pursuing another mega-fund that’s still open to investors. Lone Star Fund VII currently is targeting $4 billion and could end marketing with $4.5 billion by the end of July. Fund VII will invest in special situations, including distressed single-family residential, corporate and/or consumer loans and securities. Lone Star launched both funds in 2009 with targets of $10 billion each, but eventually it cut down those targets in the anemic fundraising environment.

Reducing its original $10 billion targets aside, it seems that Lone Star’s determination has paid off – both metaphorically and literally – in droves. Although the end result for Fund VII is still up in the air, based on how Real Estate Fund II played out, the odds of its success are strong.