Big fish, little fish: The biggest firms get bigger, and consolidation is the way of the industry, o
Author: Suzanne Franks
Are the tectonic plates shifting under the real estate landscape? The explosive growth of “super-size” investment managers in recent years has been dramatic. According to research conducted by Institutional Real Estate, Inc. and Property Funds Research, in 2013 the 10 largest managers controlled 34 percent of the total AUM of the top 100 firms, while the top 20 had more under management than the next 100 firms combined. In 2014, the data was similar: the 10 largest firms controlled about one-third of the invested capital. Thanks to successful fundraising, aggressive M&A activities and healthy capital appreciation, the major players have grown ever larger, and smaller managers seem to be overshadowed.
The rising dominance of a few mega-firms raises questions about the effects of consolidation on the broader market, from both the managers’ and the investors’ perspectives. When industry giants with huge pools of capital to deploy are positioned to capture some of the largest, most complex and often unique transactions, can smaller managers effectively compete for deals and yield? Are investors willing to entrust their capital to small and mid-size advisers? And can small shops attract and retain professional talent in the face of increasing competition for experienced personnel?
Behind the numbers
Before trying to find the answers, it is important to look closely at the underlying data. When you actually crunch the numbers, the conclusion is somewhat different: The big managers have grown in large part because the entire real estate pie has grown significantly. The AUM of the 100 largest managers grew from $1.2 trillion at the end of 2008 to almost $2.5 trillion at the end of 2014 — an increase of 105 percent, or an average of 17 percent per year — according to the annual Global Investment Managers survey conducted by Institutional Real Estate, Inc. and Property Funds Research. But the growth of the top 10 managers was more measured — from $503 billion at the end of 2008 to $823 billion at the end of 2014, or an average of 11 percent per year. In fact, AUM of the top 10 managers grew by only 63 percent during this six-year period — well below the industry’s growth as a whole. So while some sizable players certainly exist today, the expansion has benefited many participants, not only a few at the top. The top 10 investment managers accounted for 42 percent of the assets under management measured by the IREI/PFR survey at the end of 2008; by the end of 2014, the top 10 accounted for only one-third of the total.
A major factor behind the growth of the real estate pie has been a shift in investor perception; real estate is no longer seen as a risky asset class but as a staple of a well-diversified institutional portfolio. Investors welcome strong cash flows from rental income, particularly in an era of low returns from fixed-income assets, while the volatility of the stock market can be mitigated by the more deliberate appreciation of a property portfolio.
At the same time, real estate investment options have grown dramatically; many advisers now boast global operations and a broad range of products with a variety of strategies, risk profiles, structures and return projections. Since 2008, an average of 26 funds have closed every quarter, with an average of $650 million in capital per fund. Clearly, investors have many choices.
An analysis by IREI and Kingsley Associates of the number of managers hired to advise on U.S. real estate underscores this range of choice. In spite of a stated preference for fewer, not more, advisers, the number of advisers per pension fund has continued to grow. In 2015, institutional investors employed an average of 25 third-party managers for their real estate portfolios, up from about 15 in 2011.
And capital for investment in real estate is plentiful today, particularly for assets in the United States. Interest in property in Europe, Latin America and even Asia has diminished as the U.S. economy has slowly recovered, while the rest of the world has lagged.
Slicing the pie: the competition for capital
Still, as the big get bigger, can managers of all sizes continue to grow, or will Darwinian competition winnow the field? Tom Shapiro, president and CIO of GTIS Partners, believes ample opportunities exist for the savvy adviser, large or small. “The sector funds offered by specialized managers are increasing their market share. People who have strong track records and who focus on specific market niches — geography, property type or investment structure — will successfully raise capital,” he explains. “You have to look for opportunities that others may not be tracking.”
In other words, size is not the overriding criteria in choosing an adviser; in the final analysis, performance is a trump card. “There are fundamental drivers to building a successful real estate investment management platform,” observes Mike McMenomy, global head of investor services at CBRE Global Investors. “Chief among them is investment performance. Those who control capital will measure performance, and capital will flow to advisers who demonstrate their ability to deliver as promised.” He notes markets today offer a range of investment solutions: global, sector-specific, property subtype, risk profile, among many others. “Investor capital will seek those solutions that their portfolio requires at any given time,” adds McMenomy.
Nathan Paine, senior vice president at Prologis, concurs, noting, “Smaller firms can often do well thanks to the business acumen of the founder or senior executives — i.e., performance. Good performance, transparency and proactive communication are the keys.” He cautions, however, investors today also require high standards of corporate governance and a substantial technology infrastructure.
Large pension funds sometimes establish special criteria that encourage niche players to compete for designation as an “emerging manager.” In addition to AUM, criteria include the number of funds successfully managed and the number of years the firm has been in business. This gives smaller advisers the opportunity to forge relationships with some of the industry’s major players. Emerging managers have the chance to prove themselves, with the potential for additional capital if they perform well. Although the bar for first-time advisers has been raised in recent years with increased regulatory requirements, firms with a specialized investment niche, some organizational depth and scale, and a documented track record can find a place at the table.
Not much opportunity exists for small generalists any more, though. “The days of two guys successfully raising a diversified fund are probably over,” says Shapiro. For smaller investors seeking core options, diversification and transparency are critical, and one of the large open-end funds managed by established advisers is often a good fit. About 20 such funds are in the market today, both diversified and targeted; many have graduated fee schedules to accommodate investors of all sizes.
Today, multiple sources of capital are available to real estate managers. Aside from the largest players — pension and sovereign wealth funds — they can look to endowments and foundations, high-net-worth and ultra-high-net-worth individuals, and family offices for commitments.
Competing for deals
Smaller investors also can work comfortably with specialized boutique shops, where both capital commitments and acquisitions are more modest in size. Smaller managers, in fact, have certain inherent advantages when it comes to finding investment opportunities. David Butler, managing partner of Argosy Real Estate Partners, explains that by operating efficiently in the lower-middle-market segment ($5 million to $15 million in equity) where capital is less plentiful, boutique firms can find joint venture partners who have interesting opportunities to offer and are eager to execute. “We have to work harder to be efficient, but we are nimble and can find attractive deals in underserved market segments,” says Butler. “Many of our operating partners tell us they have difficulty finding equity for smaller opportunistic investments, given the general trend toward larger funds. This has resulted in less competition for us.”
Butler notes operating efficiency is critical for boutique firms because smaller investments mean more transactions are needed to deploy capital. “We have been able to operate efficiently by being focused on very specific strategies, as well as building out a strong operational infrastructure to source, execute and manage our investments,” he says.
While firms further down the size spectrum have been achieving evolutionary growth by steadily expanding their portfolios through targeted acquisitions that support their specialized strategies, several of the industry’s mega-firms have been growing through huge portfolio M&A transactions. CB Richard Ellis Group’s 2011 acquisition of most of ING Group’s global real estate operations, and this year’s purchases of KTR Capital Partners by Norges Bank Investment Management and Prologis, and of GE Capital Real Estate by Blackstone Group and Wells Fargo & Co. are only three examples.
Is this the maturing of an industry?
As firms both large and small have recovered from the recession and grown their AUM, the hunt for talented professionals has grown more intense. But, again, real estate advisers of every size have a story to tell and advantages to offer. Besides competitive pay, there is, perhaps, a better opportunity to make partner in a smaller organization, as well as the potential for awards of carried interest in new products. And today, corporate culture is often a big part of the decision. The chance to work in a more intimate environment, and the opportunity to influence the firm’s direction, can be attractive.
Perhaps the tectonic plates underlying the real estate industry are not shifting after all. Undeniably, a small group of heavy-hitters is dominating the headlines. But it is also true real estate as an asset class has achieved a permanent place in diversified portfolios, as investors both large and small routinely allocate a portion of their capital to some form of property.
As a result of increased acceptance, the industry has grown significantly in recent years, and while real estate, as with other asset classes, will have its ups and downs, it appears abundant growth opportunities are available for advisers of all sizes.
Suzanne Franks is a freelance writer based in New York City.