It's the point in the real estate cycle where early opportunity and value add funds sell assets and pay back investors typically with extremely solid returns. If you invested in apartments or office in major downtowns in 2009 or 2010 you have done rather well. Hotels have also escalated in value and industrials have rebounded. It's time to cash in.
So what should investors do with the proceeds? And what about their advisors or general partners—what's their game plan and what should they do?
Well, the advisor-GP gambit is easy. They have their next generation fund ready to take proceeds from the cashed out fund. “You did so well in Fund I, so re-up for Fund II or by now Fund III… Even though apartments may have run their course, we're doing office in secondary markets now, or maybe its strip retail in Southeast growth areas or we have an Asia or Europe fund or how about development. The time is right.”
The sales pitch aside, advisors simply want to recycle your money and will claim they can get you the same returns they just paid out from investments bought opportunistically at near cyclical bottom even though the easy market timing play is gone—albeit give them credit for pulling the trigger when they did. Their business is to invest capital and make fees—and they want to capitalize on fund raising off the momentum of recent performance. Backing off now means downsizing the business—what investment manager would do that? And can you blame them?
For pension funds and other LPs, the question is what to do with their money? Do they take their gains and turn more conservative as the economic recovery appears well advanced? But then unemployment has declined, the first quarter GDP drop was weather related, and now maybe wage growth can start to kick in, giving a further boost. The economy has been slow growth, but the turtle-like pace may have years to run, and pension plan sponsors, in particular, require outperforming investments to meet yawning liability gaps. “These guys just delivered for me. Why not go with them again? How can I be faulted by my board for re-upping with a winner.”
So here we go again—the plan sponsor or the affluent individual reallocates into the next generation fund. The GP/advisor takes its management fee and acquisition fee off the top and plunges ahead on the new investment strategy promising the same results. It takes a year or two to put out money at fulsome pricing and by that time the economy could be looking really long in the tooth, if it hasn't hit a hard bump already. The value-add strategy gets caught in a leasing downturn and the pro forma rents on the construction project coming out of the ground cannot be met… Fund II and Fund III struggle… The GPs get their fees, but promotes fail to materialize, and the investors are disappointed, some very disappointed.
The good news is low interest rates continue to protect investors and leverage has not yet gotten out of hand… But inflation is ratcheting up and the world is a mess… It's the same old story—those Fund IIs and IIIs never end particularly well.
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Jonathan D. Miller
A marketing communication strategist who turned to real estate analysis, Jonathan D. Miller is a foremost interpreter of 21st citistate futures – cities and suburbs alike – seen through the lens of lifestyles and market realities. For more than 20 years (1992-2013), Miller authored Emerging Trends in Real Estate, the leading commercial real estate industry outlook report, published annually by PricewaterhouseCoopers and the Urban Land Institute (ULI). He has lectures frequently on trends in real estate, including the future of America's major 24-hour urban centers and sprawling suburbs. He also has been author of ULI’s annual forecasts on infrastructure and its What’s Next? series of forecasts. On a weekly basis, he writes the Trendczar blog for GlobeStreet.com, the real estate news website. Outside his published forecasting work, Miller is a prominent communications/institutional investor-marketing strategist and partner in Miller Ryan LLC, helping corporate clients develop and execute branding and communications programs. He led the re-branding of GMAC Commercial Mortgage to Capmark Financial Group Inc. and he was part of the management team that helped build Equitable Real Estate Investment Management, Inc. (subsequently Lend Lease Real Estate Investments, Inc.) into the leading real estate advisor to pension funds and other real institutional investors. He joined the Equitable Life Assurance Society of the U.S. in 1981, moving to Equitable Real Estate in 1984 as head of Corporate/Marketing Communications. In the 1980's he managed relations for several of the country's most prominent real estate developments including New York's Trump Tower and the Equitable Center. Earlier in his career, Miller was a reporter for Gannett Newspapers. He is a member of the Citistates Group and a board member of NYC Outward Bound Schools and the Center for Employment Opportunities.
