Should Investors Be Worried About the Private Real Assets Fundraising Frenzy?
Meagan Nichols
Answers to our clients’ questions about market action and the market environment in a few paragraphs every two weeks.
No, but investors navigating the robust fundraising environment should be selective when making commitments in 2019.
Real assets fundraising activity in 2018 was record breaking. We estimate that over 360 new funds were launched, targeting more than $300 billion across real estate, infrastructure, and natural resources. That target level marked a new high for real assets and was a notable increase over the 2017 level. In fact, we have not experienced such a frenetic fundraising environment since just prior to the global financial crisis (GFC). Considering investors’ thirst for yield, the diversifying properties of real assets, and the uncertain economic environment, this activity isn’t surprising.
Yet, we are not worried about the fundraising frenzy. Why? For one, capital raising activity is more diversified than in 2007. At the prior peak, fundraising was concentrated in real estate, with over $180 billion of the $251 billion (or 70%) going mostly to value-add and opportunistic real estate strategies. Today, real assets fundraising activity is more diversified, with $106 billion being raised for private infrastructure, $136 billion for private real estate, and $48 billion for private equity energy.
We also believe fundamentals remain broadly in check, even if there are areas of weaknesses. In infrastructure, the 200% jump in fundraising over the last decade was fueled by global population growth, aging existing infrastructure in the developed world (most of which was built decades ago), growth in emerging markets, and a shortage of capital due to strained government budgets and new bank capital requirements. The OECD projects that the level of infrastructure investment needed will equal 3.5% of world GDP annually through the year 2030. In the United States alone, it is estimated that $4.6 trillion of infrastructure spending will be required by 2025 1 to fix the country’s roads, bridges, dams, and other infrastructure.
Fundamentals for real estate also appear reasonable, but they have begun decelerating as we advance in the real estate cycle. Although new supply is largely in equilibrium with tenant-demand growth, pockets of overbuilding have emerged in certain sectors and cities. In addition, cap-rate compression—a significant component of real estate returns since the market troughed in 2009—is unlikely to continue. Notably, the current lending environment is more disciplined than prior to the GFC, which has helped keep supply in check and prompted private equity real estate funds to make less aggressive use of debt financing. Given elevated asset values and increased competition for deals, investors should expect lower returns from value-add and opportunistic real estate. Managers focused on niche property types, such as student housing, healthcare-related real estate, and data centers, look poised to outperform.
While private equity energy fundamentals are weak, the asset class is raising less capital than either infrastructure or real estate and we suspect some target raises may come up short. The drop in fundraising follows moderating returns, high existing limited partner exposures, and concerns about what weak merger & acquisition markets may mean for portfolio exits. Negative sentiment toward fossil fuels is also pervasive and adds additional headwinds to managers attempting to raise funds focused on hydrocarbons. Furthermore, we estimate there is slightly more than $100 billion in dry powder in funds already raised. These factors, coupled with a relatively finite number of actionable opportunities, have resulted in intense competition for assets in the best basins. We expect it will likely take longer than historically normal for managers raising capital in 2019 to reach their fundraising targets.
We anticipate capital raising activity will continue to be robust in 2019. Given this backdrop, investors should be selective in making new commitments in 2019, with a focus on managers that have successfully navigated market cycles, rigorously controlled risk, and regularly identified idiosyncratic investment opportunities.
Meagan Nichols, Head of the Real Assets Investment Group at Cambridge Associates