Private Investors Detail New Directions, Tough Competition

Top private equity executives who spoke at DLA Piper’s 12th Real Estate Summit in Chicago last week had ample good news to share about prospects for investment, but tempered the mostly upbeat tone with notes of caution.

Top private equity executives who spoke at DLA Piper’s 12th Real Estate Summit in Chicago last week had ample good news to share about prospects for investment, but tempered the mostly upbeat tone with notes of caution.

For USAA Real Estate Co., current economic conditions raise a salient question: “How do we operate in a world where pricing is at a peak?” said Leonard O’Donnell, the company’s president & CEO. “I don’t think there’s any question that growth is going to be higher in the next two years than it has in the last two years.” USAA Real Estate’s response will be to dispose of about $1.5 billion worth of assets as it completes acquisitions valued at $1 billion. That will make the firm a net seller for the second consecutive year.

Pamela Herbst, managing director & head of direct investments for AEW Capital Management, noted that the firm is continuing to invest in most U.S. core markets. “We think we’re going through a major renaissance in energy,” a trend that makes AEW bullish on Houston, she said. “We’re also excited by the fact that supply has been really muted.” For every $1 billion of completed deals, the firm underwrites about $10 billion. As a result, “We have to be pretty efficient,” Herbst noted.

In a new step for Pearlmark Real Estate Partners, the firm is offering separate accounts for the first time, reported Stephen Quazzo, CEO of the Chicago-based investment management firm and the panel’s moderator. Recently Pearlmark brought in a separate account to acquire a vacant 10,000-square-foot retail asset on Boston’s Newbury Street, the heart of the city’s downtown retail district.

Ralph Rosenberg, global head of real estate at Kohlberg Kravis Roberts, likes the capital markets outlook for his firm’s opportunistic approach. “I actually think that we could be in a very benign levered real estate environment for longer” than many economists expect—three or four years, as opposed to the one- to three-year span that is more commonly predicted. That said, the firm is regularly outbid, a signal of fierce competition for the assets KKR is pursuing.

Panelists devoted a considerable part of the discussion to the challenges of launching new funds in today’s environment, citing pressures on fees, heightened client expectations and the demands of infrastructure.  “One really needs a strong capital base to get going,” president & CEO of Harrison Street Real Estate Capital. “(Clients) are busting your chops on fees at the same time they’re asking more from your organization.” Further complicating matters is unprecedented requirements for due diligence and regulatory compliance, he added.

In particular, scale is an issue. “It’s a very difficult model to sustain,” O’Donnell agreed. “You’re not going to make any money forming your $250 million fund.” As a result, he predicted, “You’re going to see continued consolidation in (investment) management. If you have a billion, a billion and a half dollars under management, it’s really hard to maintain the infrastructure.”

In light of these heavy odds, Quazzo, the moderator, had a concluding word to the wise. “Don’t go raise a fund,” he said. Referring to his fellow panelists, he quipped, “Cozy up to one of these guys with money.”