Alternative investment managers (IMs) are pursuing core and core-plus real estate investment strategies as an avenue for sustaining growth, according to Fitch Ratings.
If these funds prove to be as scalable as some alternative IMs predict, the expansion could add meaningfully to earnings over time. It could also ease the alternative IMs’ challenge of finding investments that meet return hurdles in the current competitive environment.
Core real estate strategies are aimed at limited partners seeking current yield, as opposed to the more typical alternative investor who is seeking total return. Core investing targets lower risk and lower leveraged residential and commercial properties. The strategy differs from alternative IMs’ traditional “opportunistic” real estate funds, which focus on high-risk properties with high-return expectations. Core real estate funds are also often structured as open-end funds, which are flexible for limited partners and may be thought of as quasi-permanent capital for the alternative IM, provided that material redemptions are not experienced. Investment fees for core real estate funds also tend to be lower, often a 1 per cent management fee and a 10 per cent carry fee, or just half of the 2 per cent/20 per cent scheme typical for opportunistic real estate funds.
Real estate funds are currently dominated by opportunistic strategies, which accounted for 70.4 per cent of total uncalled real estate capital as of October 2015, according to Preqin. That said, capital raised for core real estate strategies has grown rapidly since the financial crisis. Uncalled capital (i.e. capital committed by investors to a fund, but not yet invested by the manager) for core strategies amounted to USD30 billion in October 2015, up from only USD2 billion at year-end 2009. Uncalled capital for core-plus strategies, a blend of less risky properties and traditional high-risk properties, was USD12 billion in October 2015, up from USD8 billion in 2009.
An example of core-plus real estate investing is Blackstone’s and Ivanhoe Cambridge’s recent announcement to acquire New York’s residential apartment complex Stuyvesant Town-Peter Cooper Village for about USD5.3 billion. This type of very large and long-tenured investment is suited for a core-plus strategy given that it is less dependent on widespread rental increases for returns. The deal fits the capacities of Blackstone’s core-plus fund, which had nearly USD8 billion of committed capital at 30 September, 2015.
Carlyle is also launching a core-plus real estate strategy, according to remarks made by co-founder David Rubenstein at a recent industry conference. Rubenstein pointed to targeted returns in the 9 per cent-11 per cent range for core-plus, versus 15 per cent-18 per cent for opportunistic and 4 per cent-6 per cent for core.
With Blackstone and Carlyle initiating the core-plus real estate strategy, Fitch believes other large alternative IMs may follow, as all have sought to expand their real estate franchises in recent years.
Challenges for alternative IMs pursuing core and core-plus strategies include the potential cannibalisation of their existing investor bases, as some investors may have real estate allocations that would be spread across both opportunistic and core strategies. Additionally, it is possible that some investments blur the line between core and core-plus, or core-plus and opportunistic, introducing further fund allocation considerations.