US NEWS: The summer of mega-fund love

Private equity giants like Blackstone are discovering that some LPs are eager to invest in large real estate funds again, putting multi-billion dollar targets well within reach. PERE Magazine, September 2011 issue

So far, it appears as though attempts by The Blackstone Group, Brookfield Asset Management, Starwood Capital Group and Lone Star Funds to bring the mega-fund back in style are working, particularly with American pension funds.

Several firms currently are raising capital in excess of $1 billion, and many of them are enjoying some early success, thanks to institutional investors willing to commit large amounts. Of course, another possible explanation for these mega-funds doing well is the fact that the sponsoring firms are offering incentives such as reductions in management fees. Or, it simply may be the right time to invest in distressed properties.

The true reason is likely a combination of all three, and many private equity giants are realising that their determination is beginning to pay off. As one fundraising professional said, LPs are willing to invest in these funds because “it’s all about track record and performance during difficult times.”

Paul McEvoy, senior managing director at DRA Advisors, said: “Several of these institutions have made only nominal investments in the past three or four years, so it makes sense that they’ve come back to the well. The risk-return situation for real estate compared to other asset classes has become favourable.”

Lone Star’s successful close of Lone Star Real Estate II on $5.5 billion in June, was followed up by Blackstone bringing the fundraising for its latest global real estate fund, Blackstone Real Estate Partners (BREP) VII, past the $4 billion mark. This quick first close on the New York private equity giant’s latest vehicle – the launch of the fund was announced this spring – was due in part to large commitments from such US pension funds as the New Jersey Division of Investment and the Pennsylvania Public School Employees’ Retirement System (PSERS), each of which committed $300 million to the $10 billion opportunistic vehicle.

Many other firms also have won commitments over the summer. KSL Capital Partners III closed with $2 billion in commitments, well over its initial target of $1.5 billion. Meanwhile, DRA Advisors is preparing for a close on its value-added US real estate fund after already receiving equity commitments of $662 million for its $1 billion DRA Growth and Income Fund VII.

Even firms with funds less than $1 billion have seen some success this summer. Alcion Real Estate recently closed its second fund with $500 million in commitments, or $100 million over its initial target. And DivcoWest recently had a first close of $155 million for its $400 million DivcoWest Fund III.

Others have found favour with Asian LPs. For example, the National Pension Service of Korea committed $150 million each to value-added vehicles of Invesco Real Estate and Cornerstone Real Estate Advisors, plus $150 million to Colony Capital’s distressed credit fund. 

Part of the reason has to do with it simply being the right time for institutions to commit large sums to these vehicles. For example, PSERS documents highlighted BREP VII’s preference for distressed and under-managed assets that could trade below market pricing levels and which Blackstone intends to reposition and sell at higher values.

Of course, firms will offer inducements to early investors, which could also explain a flurry for new funds. In the case of BREP VII, Blackstone is offering LPs who commit $300 million or more a management fee reduction of 25 basis points to 1.25 percent, according to documents from the New Jersey Division of Investment. In addition, the documents pointed out that “investors participating in the first close of the fund will receive a management fee waiver for four months,” equating to a savings of roughly “$1.25 million based on a $300 million investment.”

While fundraising statistics for 2011 are anemic compared to years prior to the global financial crisis, this summer’s level of mega-fund activity was unheard of just 12 months ago. All of this could change in the fall, however, as the majority of these launches, commitments and closings occurred before the US debt ceiling showdown, America’s credit rating downgrade and the ongoing sovereign debt crisis in Europe.