Internal real estate platforms for limited partners

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Direct real estate investments by insurance companies, pension funds and sovereign wealth funds (SWFs) have increased markedly since 2010. Yet for organizations considering taking their real estate investment function in-house, the challenges are extensive. Take a closer look at the issues below.

Direct real estate investments increase

Direct purchases have broadly matched the capital allocated to general partners (GPs), and while the vast majority of limited partners (LPs) still make allocations to fund managers, they are increasingly complementing these investments with direct transactions.

EY - Direct real estate investments increase

2016 is set to be the fifth consecutive year in which direct acquisitions exceeded US$100b. With the exception of 2015, private equity real estate fundraising globally has broadly kept pace with the increase in direct investments:

  • Roughly 94% of all institutional investors rely on external fund managers for at least some of their investments.1
  • 71% of institutions with less than $US50b of assets under management (AUM) outsource their entire real estate portfolio to third-party managers.2
  • 47% of institutions with greater than $US50b of AUM rely on external fund managers to handle their entire real estate portfolios.3

EY - GP fundraising vs. direct insurance, pension, sovereign investment ($USb)

Direct acquisitions may be taking capital away from potential fund allocations, but the depth of competition in the GP market is likely a bigger impediment to fundraising.

There are a record 513 funds in the market trying to raise capital — more than at any time since 2009.4 The time spent in the market for most funds continues to increase – up from 14 months in 2010 to 18 months in 2016.5

And for funds that have raised money, competitive transaction markets are challenging their ability to deploy that capital in an accretive manner – dry powder now stands at US$230b, up from US$210b in 2015.6

Taking real estate investment functions in-house

EY - Overhead as a % of assets vs. total assets

For LPs considering taking their real estate investment function in-house, the challenges are extensive.

While cost is not necessarily prohibitive, it is challenging to identify the true cost of a real estate platform. This is because there is a lack of consistent and transparent insurance, pension and sovereign reporting.

Unique approaches also mean there is no standard metric; every platform is different. The US real estate investment trust industry provides some interesting points around cost, but the results are skewed because most companies are single-sector domestic entities.

What is clear, however, is that sector diversification tends to add cost if and when synergies cannot be exploited, and while scale can bring cost efficiencies, international platforms are relatively expensive.

Real estate platforms are highly complex. Building a platform that can adequately combine people, process and technology to effectively deliver a first-class real estate investment management business is extremely challenging.

EY - Internal platforms: key considerations

Any LP considering its own platform needs to address six fundamental areas:

  1. Functionality: establish effective and efficient processes in the right locations.
  2. Governance: define risk and control frameworks.
  3. Technology: define and assess platforms and architectures on an ongoing basis.
  4. Client: identify key drivers and define products and services to support investors.
  5. Data: define global data standards and governance as well as proper architecture for tax, regulatory and financial reporting analysis.
  6. Organization and people: assemble an organization composed of the right people with the right skills in the right locations.

Conclusion

Over the next few years we expect to see the lines between fund allocations and direct investments blur further. But the complexity surrounding people, processes and technology means all but the largest LPs are likely to continue to utilize a range of approaches — including fund allocations — to meet their real estate investment needs.

1 D. Jones and D. Weill, “Institutional Real Estate Allocations Monitor,” Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates, LP, © 2016 Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates, LP.
2 Ibid
3 Ibid
4 “The Q3 2016 Preqin Quarterly Update,” Preqin, Third Quarter 2016, © 2016 Preqin Ltd.
5 Ibid
6 “The Q3 2016 Preqin Quarterly Update,” Preqin, Third Quarter 2016, © 2016 Preqin Ltd.

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