During the life cycle of a real estate investment outfit - from fundraising, to investment and on to exit – scale is the one of management’s core strategic questions. In the traditional, human resource-intensive business of real estate investing, scale is key to achieving a sustainable business, mitigating risks and providing managers with a reasonable exit option. Moreover, to amalgamate costs to a percentile that can be swallowed by investors and defended by managers, scale is key to giving managers the return that motivated them to begin the venture.
Scaling a real estate investment business also provides a good ‘brand management’ tool. The greater the number of investments and funds a manager looks after, the less the risk of an all-out loss, and the greater the potential of an outstanding winner. The winners can then be promoted very actively while the losers are wound down and quietly discarded. Advertising and promotion ensures that there is a media bias towards acquisitions, profitable disposals, large-scale sales mandates. Rarely do we read about either large or small scale failures of investments and investment managers. Acknowledging the bias towards success is the first step in enabling a more transparent and accountable investment process.
In any event, every business is started with the expectation of success. From the very beginning, private equity structures are based on a clearly defined distribution of profits (i.e. monies received after investors recoup their original investment plus a defined basic return). For successfully delivered business plans, managers achieve returns that are several orders of magnitude larger than the – often nominal – amount they have invested. Although many a private equity business plan is designed with the inherent expectation of eventually evolving into a public entity, the appeal of the private equity structure for both managers and investors is clear: strong profits without the difficulties of managing the regulatory aspects pertinent to publicly listed vehicles.
Given its appeal, the private equity real estate sector has seen capital flow rapidly in the direction of the key managers – existing and new – in recent years. Although the first half of 2017 saw the lowest level of private equity funds raised in five years, a significant sum was made available to private equity real estate managers: $46.9 billion of new capital globally. Blackstone reigns supreme – accounting for almost 20% of the total capital raised in the period, at $8.9 billion for its Real Estate Fund V.
Record low yields on bonds and stock prices have caused limited partners – those who have more money than time to manage it – to pour money into property. Even though external compliance and epistemic pressure makes it difficult for managers to get an allocation of capital for new investment vehicles, property continues to attract relatively vast sums.
Hopefully, in the long term, as investors gain a greater understanding of the functioning of the real estate investment machine, greater awareness of the structure of investment vehicles and of the methods of compensation and potential risks associated with investing, and learn that they are the ultimate bearers of potential losses, the market will become more accountable, transparent, fair and sustainable.