With Billions of Dollars Pouring In, Private Equity Is Challenged to Keep Real Estate Streak Alive
TPG Real Estate Partners Becomes the Latest Firm to Draw Billions of Dollars to Invest

By Mark Heschmeyer
CoStar
Published: Mar 13, 2019

Here's the enviable problem for private equity firm TPG Real Estate Partners: Its latest opportunity fund, TPG Real Estate Partners III, landed $3.7 billion of capital commitments and was oversubscribed by about $700 million.

So why's that so bad? Because the San Francisco-based firm, like some private equity real estate counterparts, has to find a dwindling number of places to put all that money that could prove to be good investments.

Like many private equity firms, TPG is benefiting from the strong investor demand stoked by a long stretch of growth in values of commercial real estate, which mirrors the near-record expansion of the U.S. economy. Keeping up that performance is getting more challenging as demand weakens. TPG's previous real estate fund closed in October 2015 with $2 billion, about 85 percent less than the pile of capital that investors committed to its latest fund.

Performance of private real estate investments over one-, three-, five- and 10-year periods typically outperformed most public markets and other private capital strategies, according to new analysis from private equity data provider Preqin.

This has resulted in general satisfaction among investors toward their real estate portfolios. More than a quarter of investors Preqin surveyed said their real estate investments exceeded expectations over the past year.

Furthermore, capital distributions back to investors have been strong, with 2017, the latest full-year data available, marking the fifth consecutive year in which investors have had positive net cash flows.

The amount of money involved is also significant. U.S. private equity firms raised $124 billion in 2018, the sixth straight year above $100 billion, while private equity real estate assets under management reached a record $909 billion.

Cash flow profits back to investors surpassed $200 billion for the past three years. Consequently, investor appetite is strong, with a far greater proportion of investors looking to increase their allocations to real estate over the longer term, at 36 percent, than decrease the allocations, at just 10 percent, meaning the strong fundraising environment of recent years is likely to keep going.

However, Preqin noted, there are challenges ahead. More than half, 55 percent, of fund managers have witnessed increased competition for portfolio companies, and there are more funds than ever before in the market competing for investor capital, now 670 funds are seeking an aggregate $244 billion.

Fund managers therefore have to work harder than ever to secure capital, put it to work and deliver to investors.

"That said, opportunities still exist, albeit perhaps they are harder to identify, and fund managers and investors alike will have to work hard to select the most appropriate strategies, geographies and partners to ensure real estate continues to deliver," Preqin analysts said.

Buying Property Companies

For its part, TPG Real Estate Partners is sticking with what has worked for it in the past. The firm's strategy is primarily focused on acquiring and building property companies as opposed to strictly properties.

"From self-storage to senior living, we focus on building property-rich platforms in high-growth asset classes and markets, as well as in select areas of dislocation," said Avi Banyasz, partner and co-head of TPG Real Estate, in announcing the fundraising. "Looking ahead, we will continue to execute our strategy of investing in real estate-intensive businesses, particularly in sectors where we believe we have proprietary insight and operational competitive advantages."

The amount of private equity capital sitting on the sidelines awaiting a good commercial real estate deal, often referred to as dry powder, stands at record levels, extending the cycle and pushing prices beyond "normal" highs, according to new Morgan Stanley research.

The difficulty deploying capital could drive some of that money to acquisitions of real estate investment trusts.

At year-end 2018, $295 billion of commercial real estate dry powder needed to be deployed, with North American funds accounting for 62 percent.

"We think it's inevitable that REIT M&A activity will increase, but it may be focused on quality," according to Richard Hill, lead analyst with Morgan Stanley Research. "In our view, it will be very difficult to deploy all of the existing dry powder and new money in one-off property transactions. We think REITs are likely candidates, but not necessarily those that are trading at the greatest discounts to consensus [net asset values]."

Historically, REIT mergers and acquisitions activity shows that target companies are usually trading close to their 52-week highs and at discounts to net asset value are negative 10 percent on average, Morgan Stanley analysis shows. Other funds are drifting to other opportunities, including contrarian investments.

AmCap Inc. in Stamford, Connecticut, owns and manages grocery and other necessity-anchored shopping centers through its institutional investment arm AmCap Management. The firm announced its first private offering to retail investors, the AmCap Necessity Retail Fund, seeking to secure capital commitments of $100 million for its launch.

"Disruption in a number of retail categories due to the changing economy presents excellent investment opportunities for AmCap, as an owner/operator, to capture additional income through property improvement and increased rental rates," said Ed Cofrancesco, president and chief executive of International Assets Advisory, which is managing the offering.