Raising a Private Equity Real Estate Fund: New Challenges; New Rules

In a report recently published by a leading industry researcher, fundraising activity continued at a slower pace in the first quarter of 2010, achieving a slight improvement over the fourth quarter of 2009. A combination of slowing cash flow and general uncertainty about the market dampened investor appetite in late 2009 and early 2010. An additional factor not as widely mentioned is investor sentiment toward the real estate market, as well as toward fund operators.  
 
There is no question that in many cases investors in these funds have been burned badly.  In some cases, this was avoidable and others perhaps not as much. However, data indicates that the outlook for fundraising is encouraging as investors still seek to retain real estate as part of their overall investment strategies. A recent Preqin survey revealed that 51 percent of investors are planning to commit more capital to private equity in 2010 than in 2009 with only 8 percent anticipating a reduction. What’s different is the time it is taking for fund mangers to close their vehicles. This is not surprising as investors are being cautious as well as paying much stricter attention to the proposed terms and conditions of the vehicles they are considering investing in. 
 
So what are limited partners paying close attention to during their underwriting of a manager? Which terms and conditions are getting the most scrutiny and which are not as critical? Knowing this information can help a fund manger to structure their fund and the marketing for it. A recent survey of leading placement agents showed the rating of certain fund terms and conditions according to how pressing they have found them to be to LPs in 2010. The interesting and perhaps surprising result was that while management fees still ranked relatively high in average rating of importance, it was not the most important issue. Proceed distribution structure ranked at the top of the list, with payment of fees on uninvested equity coming in second. Management fees ranked third, although this was the area in which LPs indicated they had witnessed the greatest change in the past year, with mean management fees dropping 50 basis points compared to 2007.
 
Many say fundraising is tough, but that is only true relative to how easy it was a few years back. However, it is tougher to gain a commitment as LPs are engaging in more thorough and more detailed due diligence of managers, investing only with those who are like-minded and employ investment strategies that are tolerable to their risk appetites. GPs have to work harder to attract this capital, which is OK because it will hopefully help weed out those fund managers who are not qualified to be in this space. 
 
For those contemplating starting a new fund, the importance of crafting and telling your story is more critical than ever. And because there is still relative calm in the marketplace, now is the opportune time to ramp up and be prepared with a fund to take advantage of opportunities that are sure to come at the end of 2010 and in 2011. 
 
LPs have become more sophisticated and will continue to wield influence when negotiating fund terms and structures. However, equity is eagerly waiting to be invested withmanagers who posses integrity and openness, and have true real estate management skills. Alignment of interests is critical and a well-defined investor communications
program is a must. Remember, it is not about "selling" but about "compelling" an investor that your defining differences are worth of their dollars.

Sagar A. Dalal is the co-founder and managing principal of Beckerman’s real estate fund advisory division. The division works with real estate fund managers by advising on all
aspects of the private fund placement process including fund structuring, competitive positioning and market assessment, preparation of fund-related documentation and providing
expert fund communication advisory services to fund managers to ensure a productive and successful relationship is maintained with current and prospective investors. He can be
reached at [email protected].