In addition, a number funds that were already in the market seeking capital were able to close out this year. Among the many were: AMB Property Group closed out its $400 million AMB Institutional Alliance Fund II; Fidelity Management Trust Co. closed its $321.1 million Fidelity Real Estate Growth Fund LP; CIM Group closed its $180 million California Urban Real Estate Fund LP; and Northstar Capital Investment Corp. closed on the first $100 million of its NorthStar Funding LLC which will invest in mezzanine debt.

Through the 1990s, real estate funds, which are pools of investment capital that invest in real estate usually over a period of 10 years, basically took the form of opportunity funds which promoted higher risk-higher return philosophies. Total assets in these funds have grown to $150 billion. Since the domestic real estate market has stabilized as compared to early 1990s, the potential returns for opportunity funds have diminished and some of the real estate funds being promoted now are trying differentiate themselves with new labels. For example, the Fidelity Real Estate Growth Fund is billed as “value-added” fund.

“If you look at the spectrum of risk, core funds have the lowest returns, opportunity funds the highest and somewhere in between are value-added,” explains Lee Sandwen, group head of Fidelity’s real estate unit. Opportunity funds generally projected returns of 20% or greater. Value-added funds try for returns in the high teens to low 20 percent.

These definitions aren’t fixed. Peter Palandjian, chairman and chief executive officer of Intercontinental Real Estate Corp. uses slightly different terms and scales. He puts core funds at a 7-9% return, core enhanced at 9-12% returns and opportunity funds at 15-22% returns. Intercontinental Real Estate’s new fund falls into the core enhanced range.

In any case, the middle ground, whether it is called value-added or core enhanced has been carving a bigger niche this year for the simple reason that opportunity funds are increasingly moving to overseas investments, which at this point in time offer the best opportunities for the higher returns. The core enhanced and value added funds are all oriented to U.S. investments. The companies putting these funds together obviously feel investors would take a slightly smaller return to avoid the risk of investing overseas.

The value added funds are going to be quite attractive going forward, says Sandwen, at least compared to returns in other asset classes. Fidelity intends to attain these returns by investing in new multifamily development.

Divco West’s fund, which is billed as an opportunity fund, is attempting to raise $350 million to $500 million so as to invest in the real estate carnage left behind by the tech and Internet collapse in the Silicon Valley area.

Intercontinental Real Estate Investment Fund III is targeting returns of 15 percent and hopes to get there by investing in a variety of commercial properties mostly in the Northeast. Twelve pension plans have already coughed $75 billion to invest – the fund’s goals is $250 million. The term of the fund is 10 years, minimum investment required $1 million and investments will be leveraged 60-65%.

While yes there does seem to be a lot of real estate funds raising capital, says Palandjian, the market, especially in regard to institutional players, looks a lot like the Jekyll-Hyde character. On one hand, allocations on a percentage basis have increased as “the bursting of the tech bubble has reminded people why diversity in a portfolio makes sense,” says Palandjian. In July, the $1 billion University of North Carolina at Chapel Hill endowment reported it increased its real estate allocation from 5% to 7.5% because an in-house allocation study showed real estate represented a good investment opportunity relative to other allocations.

“On the other hand,” says Palandjian, “the so-called denominator effect had kicked in.” What Palandjian refers to is the fact that other asset classes have gotten so beaten down, that if a plan sponsor intended to move from an 8% to 9% allocation in real estate, it might have come automatically, without added investment, as the 9% became a smaller number.

The CIM Group’s California Urban Real Estate Fund LP closed on July 1 with $180 million in equity commitments, the bulk of it coming from California State Teachers Retirement System and California Public Employees Retirement System. John Lustgarten, finance director of the Los Angeles-based company, says the new fund is an opportunity fund and is targeting returns of better than 20 percent. It hopes to attain that goal by leveraging the fund to invest in $450 million of mostly California real estate including a mix of housing, office, retail, entertainment or parking projects in urban districts throughout the state.

“We are not going to be out there acquiring Class A office buildings,” explains Lustgarten. “We are looking for underserved real estate in high density population areas.”

Lustgarten, too, believes there is a huge opportunity now for real estate funds despite, the schizophrenic nature of the market. However, Lustgarten’s take on plan sponsors is slightly different from Palandjian. He agrees with the Intercontinental CEO that other asset classes have deflated, nevertheless Lustgarten maintains, despite the recent weakness of other asset classes, so much money had been made in equity investments in the late 1990s, real estate had not kept up. “Now there is an interest in rounding out the portfolio,” Lustgarten says.

TimesSquare Real Estate Investors, a division of TimesSquare Capital Management Inc., launched The Industrial Alliance Fund in May, and it is aimed solely for qualified corporate and government pension plans. The goal is to raise $100 million to invest in institutional quality, bulk warehouse and distribution properties in targeted U.S. industrial markets.

William Grady, a senior vice president with TimesSquare Real Estate, calls The Industrial Alliance a value-added fund. Still, its aim is a 20% return. Perhaps, Grady doesn’t want to be lumped into the opportunity fund niche, which he says has become the real estate equivalent of a dirty rotten scoundrel. “The last opportunity fund wave has come and gone,” he reports. “The first wave did very well, the second wave of opportunity funds less well and third and fourth waves have been disappointing.”

Grady also suggests the current sweep of real estate funds is nowhere near the amount of funds that were formed four to five years ago – the heyday of the opportunity fund.

Maybe the amount of capital being raised for real estate funds today isn’t as great as in the mid-1980s, but that shouldn’t diminish what is going today, says Sanford Presant, national director of Ernst & Young’s Opportunity Fund Services, based in Los Angeles and New York. “There are billions and billions of new capital being raised from pension plans, endowments, private foundations and wealthy individuals.”

And these billions of dollars, Presant adds, are being placed because “a lot more people are organizing funds. They have seen the success of opportunity funds and the types of returns that can be achieved. In addition, once the funds raise capital they do not have to search for money for each deal.”

A good fund sponsor, if it does well, generally will have a repeat investors when the next fund gets organized, which is why so many of these real estate companies now are into their third, fourth or even fifth iteration of a fund.

“At this point in time capital raising is difficult for funds that do not have a track record, says Presant. “But, it is not discouraging people from getting into the game because there is a huge amount of money out there chasing real estate.”

Originally published September 2001

Originally from Steve Bergsman's Maverick Real Estate Investing by steve reBlogged on Jul 1, 2005, 8:59AM