2020 vision


Fund managers expect the private real estate industry to grow over the next three years, but Preqin’s Oliver Senchal warns against market consolidation

The private real estate industry faces a challenging set of circumstances: competition for deals is fierce, asset pricing is high, and fund managers are having to adapt to this environment to meet their investors return expectations. On the other hand, fundraising has been strong for several consecutive years, investor appetite is rising, and the exit environment is favourable for those managers looking to divest their holdings.

It is appropriate, then, that Preqin’s latest survey of private real estate fund managers looked beyond their immediate concerns and priorities over the next 12 months, and examined their predictions for the private real estate landscape in 2020.
The findings cover both their expectations of the management side of the industry, as well as the ways in which they think investor appetite will change.

Expanding industry

The majority of fund managers expect the private real estate industry to keep growing over the next three years. In total, 71 percent said they expected it to be larger in 2020, with 16 percent saying it will be significantly larger. This seems a reasonable expectation based on the asset class’s historic growth: assets under management (AUM) grew at an average annual rate of over 18 percent between 2000 and 2016. Even during the great financial crash, industry AUM fell just 2.4 percent between the end of 2007 and the end of 2008, and 0.9 percent at the end of 2009. This compares to growth of 48 percent in 2007, and subsequent growth of 15 percent in 2010.

However, the most recent figures would suggest that this rate of growth has not persisted in more recent years. Industry assets peaked at $808 billion in 2015, but the average annual growth in the five years from the end of 2011 was just 7 percent, and total AUM held by private real estate funds fell by 3 percent in 2016, largely due to the high levels of distributions returned to investors. Given that strong fundraising activity has continued into 2017, and that investor appetite for the asset class remains high, we may well see the industry return to growth in the coming years. But, given the slowing pace of expansion, a significant increase in the size of the market over the next three years may require a shift in market conditions.

There is also a general consensus from fund managers that their ranks will expand over the next three years. Some 42 percent said that they expect there to be more active managers in 2020, and 3 percent expect there to be significantly more. Again, this would be in line with the development of the industry, given that the total number of active real estate fund managers tracked by Preqin has risen every year since 1990.

However, the pace of that growth does seem to be slowing, as the number of new firms founded each year decreases. Net growth in active fund managers peaked at 154 new firms in 2010, and since then has declined year-on-year to just 31 in 2015. This indicates that the industry as a whole is moving closer to a point of equilibrium in which the number of active firms in any given year remains broadly level.

This may help to explain why a significant 29 percent of fund managers interviewed in June 2017 said that they expected there to be fewer firms active in 2020 than at present. Although just 3 percent expect there to be significantly fewer fund managers, this is indicative of a sense in the industry that some firms will not be able to remain active in the coming years, either due to legacy issues from the crisis, difficult market conditions or consolidation within the industry.

Capital concentration

As noted previously, the private real estate industry has been enjoying an extended period of robust fundraising, with annual capital totals exceeding $100 billion in every year from 2013 onwards. Since the start of that year, fund managers have raised in excess of $500 billion from investors, surpassing the $467 billion raised during the previous peak of fundraising between 2005 and 2008. As of the start of August, fundraising in 2017 year-to-date has reached $64 billion, which puts the industry on course to exceed $100 billion again by year end, even if it may not match the $125 billion secured in 2016.

However, there has not been a corresponding rise in the number of private real estate vehicles reaching final close. The most recent peak in annual fund closures was in 2012, when 327 vehicles reached final close globally—the all-time high was in 2007, when 395 funds closed.

Since 2012, the number of funds closed annually has remained fairly level, exceeding 300 in each year but not surpassing 327. However, 2017 looks unlikely to reach that benchmark: 142 funds closed globally in the first seven months of the year, which could suggest a year-end total of around 250. This has seen an increasing amount of capital concentrate among fewer fund managers.

The average size of private real estate funds at final close has risen year-on-year since 2010, from $263 million in that year to a record $469 million for funds closed in 2017 year-to-date. By comparison, the average size of funds closed in 2007 was $427 million, a record at that time. At the same time, the largest firms are securing more capital than ever before. The top 20 largest private real estate fund managers raised a total of $118 billion in the period of 1997 to 2006. In the following 10 years, this figure almost tripled to $343 billion.

Given these circumstances, it is perhaps not surprising that most fund managers interviewed recently by Preqin said they expect to see further consolidation occur within the industry over the next three years. Nearly four in five (79 percent) respondents said they expect to see some consolidation, and 8 percent predicted significant consolidation, while just 13 percent said they expect to see little or no consolidation.

Considering that fund managers also generally expect there to be more active firms in 2020, it may be that some of them foresee the emergence of a two-tiered fundraising market, where the largest and most successful fund managers are able to quickly raise ever larger funds, while the majority of smaller and less established firms compete fiercely for the remainder of investors’ allocations.

Outlook

It probably shouldn’t be surprising that fund managers expect the private real estate industry to keep expanding over the next few years. Given that even the sharp correction of the financial crisis did little to slow the growth in industry AUM, it seems reasonable to suggest that we can expect to see the asset class continue to grow in the foreseeable future.
However, it is curious that fund managers can simultaneously believe that their ranks will grow by 2020, and that the industry will see consolidation. It may be that these predictions are guided by the same influence: the rising levels of competition for investor capital, dealmaking opportunities and a favourable exit environment.

As it stands, though, these predictions would seem to be mostly exclusive of one another, and the most likely outcome may lie somewhere in the middle.

This may be the solidifying of a nascent phenomenon, the two-tiered fundraising market that separates the largest firms from the rest, creating two separate segments of the industry. It is difficult to say what effect this would ultimately have for the industry, but the prospect seems to be one that fund managers are starting to consider.

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