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12816353 Opportunistic Investing Real Estate Private Equity Funds

12816353 Opportunistic Investing Real Estate Private Equity Funds

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Categories:Business/Law, Finance
Published by: tower8 on Oct 02, 2010
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05/31/2014

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R
EAL
E
STATE
, H
OSPITALITY
,
AND
C
ONSTRUCTION
Opportunistic Investing:Real Estate PrivateEquity Funds
 
O
PPORTUNISTIC
I
NVESTING
:R
EAL
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STATE
P
RIVATE
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QUITY
F
UNDS
Over the last decade, the real estate private equity fund sector has flourished. Real estate value added and opportunity funds areperhaps the most prominent vehicles in this sector. The first of these opportunistic real estate private equity funds were raised in thelate 1980s/early 1990s to capitalize on the opportunities resulting from the sudden unavailability of debt capital and the abundance of available product offered by motivated sellers, most notably the Resolution Trust Company. Since that time, the number of funds hasgrown and their underlying investments have become increasingly more complex and global in address. Originally perceived asfinite-life investment vehicles, these funds have arguably become viable, infinite-life businesses able to support the operatingorganizations built to manage them.One factor supporting the proliferation of funds is the closer alignment of investor and General Partner interests. Historically,advisors/managers were hired to invest money on behalf of institutional investors, and were compensated based on the appraisedvalue of the investments; they had no equity of their own in the investments. This misalignment of interests between the investorsand the advisors became glaring as real estate values decreased in the late 1980s. Today’s real estate private equity fund structureprovides better alignment of General and Limited Partner interests because the General Partners have equity, sometimes significantequity, invested in the funds, and participate in realized gains as opposed to paper gains.Other factors helping to fuel this rapidly growing sector include the success of most of the early vintage year funds, the continuingavailability of equity coupled with a skyrocketing stock market, and expanding global opportunities. These factors have enhanced thegrowth of the sector, not only in terms of the huge amount of money raised, but also in terms of the number of funds now operatingglobally. We believe there are now more than 100 Fund General Partners throughout the world.Opportunistic real estate private equity funds are flush with capital as we enter 2002. If the sentiments voiced by fund GeneralPartners in our recent survey are on target, they are poised to capitalize on new opportunities in this ever-changing world. In fact,based on our survey results, a minimum of $20 billion of equity remains to be deployed. Further, according to our estimates based onsurvey responses and information available publicly, in excess of $90 billion in equity has been raised for opportunistic investing inreal estate since 1991. Impute leverage of 60% to these amounts and one can appreciate the significance of this sector of the industry.More recently, the trend among these funds has been to raise larger funds and to refinance existing assets to repatriate capital. Inaddition, a substantial period of real estate market equilibrium has slowed the pace of transactions domestically, increased the bid/ask spreads on properties, and has driven funds to deploy capital outside the U.S.At this point in their evolution, opportunistic real estate private equity funds are under increased scrutiny from investors seekinggreater transparency and standardization in reporting information. We believe 2002 will be a watershed year in which great stridesare made in these areas. The recent changes to the AICPAAudit and Accounting Guide for Audits of Investment Companies withrespect to the disclosure of financial highlights should help in this regard. Through our survey we tested the General Partners’pulseon the subjects of financial reporting and performance reporting. We considered the various and complex tax issues which GeneralPartners must navigate to achieve targeted yields. We also surveyed the use of technology throughout the funds' value chain as a toolto facilitate global communication, reduce costs, and create better efficiencies.Of course, it remains to be seen what impact the global recession, rising security and insurance costs, and the ability to secureterrorist coverage will have on the industry and on fund returns. The events of September 11 will certainly have profound impactson the real estate industry and in the process create new opportunities as well as new challenges.We’d like to thank the funds that participated in our survey. We hope you find the discussion here insightful as we look at thecomposition of this exciting sector and the complexities that need to be addressed if the various players are going to continue to findsuccess.Dale Anne ReissGlobal Industry Leader,Real Estate, Hospitality,and Construction Group
 
About the Survey Process
We embarked on a survey of opportunistic real estateprivate equity funds to enhance the industry’sknowledge, as well as our own, of what we have seenas a large and growing sector. The survey, whichincluded approximately 150 questions covering manysubjects, including financial and performancereporting, taxes, and infrastructure and technology, wassent to more than 100 fund General Partners, ManagingMembers, and/or Managers (collectively, “GeneralPartners”). We received 48 responses. Not allrespondents answered every question, and certainresponses were supplemented with informationgathered in personal interviews with the GeneralPartners. In total, our participants represent $72.3billion of equity raised in 145 separate funds between1988 and 2001.Ernst & Young has maintained the confidentiality of allresponses and respondents. Under no circumstanceswill the identity of the respondents be revealed to thepublic or the other respondents.In preparing this report, Ernst & Young relied on thedata and information supplied by the respondents. Wedid not attempt to verify the responses provided by therespondents, and we do not take responsibility for theaccuracy or reliability of the data.
1
Overview ofMajor Findings
Opportunistic real estate private equityfunds are also known as “value-added”funds and “opportunity” funds. Bywhatever name they are known, their success stems fromthe ability of savvy General Partners to locate andcapitalize on over-discounted risk or overlooked valueenhancement opportunities. Similar to more traditionalprivate equity funds (i.e., venture capital and buyoutfunds), these real estate funds target higher yielding (15%-plus leveraged) private investments. In addition, theytypically have an average life of from seven to 10 years,often with two one-year extensions. Generally, theyprovide for a 1% to 2% annual management fee, a 20%carried interest to the General Partner after achievement of a preferred return hurdle (typically 9% to 10%) and have asignificant individual, pension fund, and endowmentinvestor base. The General Partners (and their affiliates)typically commit 1% to 5% of the fund capital, butcommitments of those General Partners (and theiraffiliates) associated with investment banks often rangebetween 2% and 40%. Modern day opportunistic realestate private equity funds originated in the early 1990swith a proliferation in the number of General Partnersponsors beginning in 1997.
$.90$1.05 $1.05$1.69$3.08$3.63$8.21$12.69$16.90$25.34$35.56$43.91$55.27$72.27
198819891990 1991199219931994 1995 1996 1997 1998 1999 2000 2001
01020304050607080
12249112333466585102122145
   (   $   b   i   l   l   i  o  n  s   )
 
# Funds
Cumulative Fund Equity Raised(by year)

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