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Real Estate Fund Recapitalisations
Jeffrey Giller, Managing Principal and CIO
Clairvue Capital Partners
Mar 2011

Real estate private equity funds have a big issue: They need more capital, and it's not that easy to get, at least not anymore. A mere three years ago, capital was abundant. Between 1999 and 2008, investors filled real estate funds' coffers with equity capital totalling some $420 billion, nearly 80% of which was raised in the relatively short period between 2005 and 2008. During the same period, debt became overly abundant and very inexpensive, and underwriting standards became very loose. Nearly half of the approximately $1 trillion in commercial mortgage debt that has been originated since 2002 was issued in the two-and-a-half-year period between 2005 and 2007, right at the peak of the market.

So until recently, obtaining equity or debt capital was relatively easy for funds, but now, it is scarce, and scarce at a time when funds need capital the most. In this post-credit crisis environment, it is generally understood why fresh capital is so scarce, but why are real estate funds now so in need of capital? With all the money made available to them in their newly mega-sized funds, shouldn't managers have set aside sufficient reserves to cover their investments' long-term capital needs? Managers did in fact set aside enough reserves to carry their investments for their intended three- to five-year holding periods, but they were unprepared for the significantly longer holding periods brought on by the sudden freeze in transaction activity. In addition to being under-reserved, managers financed their investments with short-term debt to match their intended short-term holding periods, and that debt is now maturing. Not only were managers unprepared for the longer-than-expected durations of their holds, but they were equally unprepared for the devastating impact that the precipitous fall in property values would have on their balance sheets.

Putting these various pieces together creates a picture of the present environment, in which vast amounts of capital were committed to real estate funds between 2005 and 2008, and substantially invested into properties after 2006, straight into the market peak. In general, these investments were over-levered with inexpensive, relatively short-term debt, and the reserves set aside were insufficient to carry the assets through the market down cycle. After 2007, when market activity ground to a halt and values dropped, real estate funds were left holding large portfolios of over-levered properties that had become in breach of their loan-to-value debt covenants, had impending debt maturities and did not have enough capital to continue to carry their assets or fund their business plans.

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