Capital crunch could see real-estate funds close

Franklin Templeton’s real-estate team invests in around 350 fund managers worldwide, but if capital-raising remains as difficult as it has been of late, as many as one-third of those could be in danger of closing, warns Jack Foster, New York-based managing director and head of real estate.

The paradox is that many institutional investors are keen on real estate, and Foster expects both the United States and other markets to present good investment opportunities for those with a long-term outlook.

But the nature of investor demand is changing, Foster says.

Many pension funds and other institutions now conceptualise real estate as part of their alternative-investment bucket, as opposed to a standalone asset class. That puts it in a basket with private equity and hedge funds, which in aggregate have suffered since 2008 and are struggling to raise capital. Real estate ends up getting tarred with the same brush, and therefore property fund managers are struggling to attract institutional capital.

Secondly, LPs are now mostly just interested in core-type assets, eschewing the perceived risks in opportunistic investments. However, what is considered ‘core’ is different.

‘Core’ used to mean prime office space and mall operators, who were not leveraged, and who attracted high-quality anchor tenants on long-term leases. “Today everything’s leveraged, leases are short term, there are more non-credit tenants, and assets are lower in quality,” Foster says.

This makes investors today hesitant about committing new capital to such exposures, particularly to anything marketed as ‘non core’.

“Raising capital for non-core is hard globally, even in Asia,” Foster says. Investors looking for real assets are often looking first to infrastructure, timber or agriculture.

Thirdly, real estate has always been the last asset class to internationalise. In the mid-2000s, investors became more interested in global real-estate opportunities, but the local character of real estate is reasserting itself in people’s minds.

“Real estate isn’t about the building,” Foster says. “There’s nothing special about this building [part of Rockefeller Center] or the materials that were used to build it. What counts is what’s going on outside your window.”

Also, local taxation rules play a big role in valuing property assets; it’s not as fungible an asset as stocks or bonds.

As a veteran investor in real estate, however, Foster says the asset class now offers real value, particularly in the United States and Asia. Opportunistic assets are also now relatively cheaper, given the flight to core investing, so now is a good time for a property fund of funds to be making allocations to those managers it believes will survive.

“As risk appetites return, more money will be flowing to real estate, especially in Asia,” Foster says. “Credit and leverage from QE2 isn’t going to stay in the United States.”