A domestic governmental investor recently outlined a real estate fund search with a BHA analyst. The investor, based in Texas invests into real estate directly as well as through funds. They are quite opportunistic and are interested in core, core plus, and value add funds.

In terms of geographic exposure, they are targeting funds focused on the United States. The firm prefers experienced managers in the current market environment. At the current time they are interested in evaluating compelling opportunities.

This week, BHA analysts found a significant increase in the number of investors specifically interested in distressed real estate strategies. This is more than likely due to the turmoil that the overall real estate market has experienced during the past year to 18 months. Real estate funds are finding more and more opportunities to purchase distressed properties in the commercial and industrial spaces at substantial discounts to what many would consider their real market value.

A good example of this trend is a U.S. wealth advisor based on the East Coast. It is not seeking alpha generating programs but rather long-term players that are focusing on quality properties that will see significant gains as the economy begins to rebound.

Another investor, an insurance company in Korea, expressed an interest in distressed real estate funds specifically in the U.S. These funds have taken the brunt of the beating thus far; the value of their holdings has been downgraded and businesses of various sizes have closed locations. This company believes that over time, distressed real estate funds will begin to find opportunity horizons widening as aftershocks of the current economic situation are felt across the globe.

Finally, a wealth advisor based in Virginia mentioned that distressed is of particular interest right now for its clients. The firm seeks to present its clients with the best risk-adjusted opportunities across its portfolio. It believes that real estate funds in the distressed space will give its clients a solid long-term return that will complement its overall portfolio and ultimately hedge against short-term risk.

Of the numerous real estate investors with which BHA analysts have spoken this week, close to half expressed a specific interest in distressed funds. This ratio is an outlier when the overall percentage of investors interested in this strategy year to date is just over 15 percent. Based on this data in the coming months we may find more investors actively looking to take advantage of the recent drop in the real estate markets by taking positions in distressed real estate funds.

This week, BHA analysts spoke with a U.S. fund of real estate funds that is searching for managers running distressed, value-add, and secondaries strategies within the real estate sector. The fund of funds’ main focus for 2009 is distressed funds; its secondary interest is in value-add and secondaries focused on the U.S., Western Europe, and developed Asia (Hong Kong, Japan and Singapore). The firm does not have any specific target size for funds it invests in, however, it does require a manager to have ten years experience and hold the primary decision making role for at least five of those years. Funds should also be in the top quartile of their peer group with overall returns of at least 20 percent. When reviewing funds, the firm likes to see that leverage is used prudently and there are no recourse loans. The due diligence process will vary from four to six weeks to several months depending on the preparedness of the manager.

This week, Brighton House analysts spoke with several investors that are interested in real estate funds focused on the industrial sector. Investors have pointed to a couple of reasons for their interest, the foremost of which is the theory that industrial funds provide a steadier cash flow than other types of real estate funds.

Industrial real estate funds offer investors a certain level of cash flow stability due to the types of tenants investment properties accommodate and the lease terms that are created. Tenants renting industrial properties require the use of the facilities to operate a major part of their businesses, such as manufacturing, storage, and so on. They often sign longer-term leases and have less of a tendency to vacate due to the high costs of transporting or moving their equipment. Even in this type of economic environment, tenant turnover remains relatively low. Therefore, industrial property funds should be able to generate a consistent level of cash-on-cash returns as well as a strong long-term rate of return.

In comparison, commercial property funds investing primarily in retail or hotel properties may be experiencing quite a bit of volatility and turnover in this market environment. With smaller businesses, start-ups, and self-employed parties occupying retail office buildings, there is a good chance that tenants will default on their rent or have to move out, leaving vacancies that then need to be filled as soon as possible. Commercial property tenants sign shorter-term leases and do not find it as difficult or costly to relocate if they need to find space that offers a lower rental fee.

A few investors this week actually mentioned that they are specifically avoiding funds investing in hotel- and hospitality-related properties. With the economy where it is, leisure travel may not be an option for many people this year, leaving hotels, for example, with higher vacancy rates and lower revenues. These types of commercial properties are associated with more risk than some investors are willing to take.

Brighton House analysts expect the interest in industrial-focused funds to continue during the next several months as real estate investors look for some sort of stability in this market. Even if conditions do not improve in the near future, the long-term horizon of real estate investments provides potential for strong returns at the end of the funds’ investment cycles.

This week BHA spoke with a European pension fund that has an interest in opportunistic real estate funds focused on the industrial sector in the US. The firm is looking for industrial-focused funds because it wants stable cash-on-cash returns of 15-20 percent through the life of the fund as well as a strong IRR. The earliest it will be able to allocate is June as it has just filed paperwork for its March board meeting, and would have to wait until the June board meeting to receive approval. The firm tries to allocate $50 million to new investments and it cannot hold more than 20 percent of a fund’s assets, so managers should be raising at least $250 million.

For a long time, BHA’s research team has focused its efforts on maintaining relationships with a worldwide network of hedge fund investors. Last year, after realizing a demand for private equity funds from many of these same investors, the firm expanded its network of managers to serve the private equity market. BHA is bridging the gap once again, this time by identifying investor mandates and managers from a third major segment of the alternative investment industry—real estate.

An article featured in BHA Investor Monitor, January 22, 2009, discussed increased investor interest in real estate funds during the fourth quarter. Since BHA’s team began interviewing a greater number of investors regarding their real estate fund mandates, one trend that has become evident is the appetite for value-added and opportunistic-style real estate funds as opposed to core and core-plus. Many experienced real estate investors share the belief that this market provides the perfect opportunity to commit capital to an investment that provides high returns relative to the level of risk. Additionally, while there is some demand for funds with global mandates, many investors are specifically intrigued by opportunities in the U.S. market.

These mandates are coming from investors all over the world. One consultant based in Switzerland that works with many large institutional investors as well as families and high-net-worth individuals, said that it finds the U.S. real estate market to be very interesting right now. It is hoping to make its second investment in a real estate fund within the next few months, and it will be looking to allocate to more than one manager.

Many in the alternative investment industry believe that there is no capital flowing into funds these days, only being pulled out. But it is important to realize that some investors have reduced allocations to hedge funds in order to add to other types of investments, including real estate. There is also a large market of long-term investors that would prefer to place their capital in value-added investments during the next few years. These investors have capital to allocate now and they’re looking for the right manager.

Blakemore Foster

During the first few weeks of 2009 there has been a noticeable upward trend in the number of investors looking to gain access to and hear from real estate fund managers. Endowments, wealth advisors, funds of real estate funds, and even insurance companies have begun outlining their Q1 investment mandates to BHA, specifically noting their current searches in the real estate space.

There is a wide range of geographical interest that spans from the U.S. to the U.K. and into Asia as investors seek diversified market opportunities. One Holland-based fund of real estate funds is currently exclusively focused on Asian real estate opportunities. It began allocating to funds in this space during the past year and is looking to continue that trend. A large Asian endowment fund is focusing on region-specific real estate managers, and it is especially interested in hearing from Asian-focused funds.

BHA analysts also have found investors focusing on strategies and sectors rather than any specific geographical locations. The research team spoke with two U.S.-based wealth advisors that have a more global approach to their searches. Both want to hear from sector-focused managers. The timber, commercial, and industrial sectors were all mentioned as potentially profitable sectors to which investors are looking to gain more exposure during 2009. In terms of strategies, investors appear to be looking at a wide range, including core, core-plus, and value-added opportunities at the moment.

With the wide range of searches taking place in the real estate space right now, the only trend that has truly emerged is that investors are taking a more diversified and opportunistic approach to real estate managers at the beginning of 2009. Several investors said they would consider any strategy and geographic focus, and are far more concerned with the management team’s experience and past results. If this trend continues, it would appear that real estate managers, in a variety of specialized strategies, should see increased investor interest as long as they have a solid and proven track record and team making the appropriate decisions for the fund.

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