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FEATURE: Keeping the lights on

For many months before the US became gripped by the unfolding scandal involving disreputable fundraising go-betweens, the most reputable placement agents have been working to adapt their model. Here, PERE takes a look at the wider issues affecting the industry. PERE June 2009

Even before the US “pay-to-play” scandal broke, PERE had been examining the placement agent business. Not because we had been tipped off about any illegal activity, but because so little has been written about this side of the private equity real estate funds world.

Though sophisticated, the industry is so opaque that there is not even a recognised database that tells you a firm's standing in the industry. Want to know in percentage terms how much placement agents raise in comparison to all equity committed to a real estate fund? No chance.

However, whether over coffee in a London office near Buckingham Palace or on the phone to a San Francisco-based professional leaving the driveway of his home, it has been possible to build up a picture of what the major players are doing.

The simple truth is that they are fighting to keep the lights on given that far fewer funds are being raised.

What has happened to the capital markets and the value of their existing real estate portfolios since last fall has been quite a wake up call.

Many agents are concentrating efforts on established managers who have kept a team together through various economic cycles and who have relatively few legacy issues. At the same there are those who are supplementing their revenue by following clients away from blind discretionary pools of capital and towards club deals and other asset-specific structures.

Many placement agents are holding fees steady or even putting them up in some cases. There are some stories though of agents reducing fees in exchange for a share of the carry. For them, the money won in such a strategy is “twice as sweet as money earned”, as Paul Newman's character famously said in Martin Scorsese's The Color of Money.

The placement agent industry is low-profile, competitive and circumspect given the strict Securities and Exchange Commission regulations that govern fundraising in the US. It is therefore, understandable that very few stories surface publicly about the industry's work.

But behind the scenes, there are notable tales of placement agents being appointed by heavyweight fund sponsors who would not ordinarily use the services of an outside party to raise capital. Traditionally, those fund sponsors could have simply reached out to its existing fraternity of LPs in the expectation of a re-up.

Suddenly, though, firms are finding that they can no longer depend solely on existing LPs when raising the next vehicle. As a result, some are turning to placement agents for help and paying the necessary fees to do so.

I don't think that the demand for placement skills is going to go away, but temporarily we are seeing a trough in our business because of investor appetite.

“The placement business is going through a cyclical change,” says a senior professional at a large New York-based captive placement business. “I don't think that the demand for placement skills is going to go away, but temporarily we are seeing a trough in our business because of investor appetite. That said, we are getting calls from firms we thought we would never get calls from.”

He says these are “household names” in real estate and private equity who typically would go back to their existing investors from the first, second or third fund. However, a lot of their investors are no longer in the market.

Adjustment period

Mindful that LPs are becoming increasingly less inclined to invest in blind pool, commingled funds, it stands to reason that placement agents are spending more time with established managers that have a track record and an established team without too many legacy issues. Those, after all, are the GPs who are much more likely to succeed in raising capital.

But it also stands to reason, that given that there are far fewer funds being raised, some placement agents are taking on work related to setting up non-blind pool vehicles.

For example, San Francisco-based Probitas Partners says scalable “club deals” – in which there are a handful of investors each committing around $100 million or more of equity – are the types of deals well suited for the current market. Especially when the fund manager involved is an established team with a distressed track record, and no legacy portfolio issues.

With most investors today wary of “blind pool” investments, placement agents PERE spoke with say LPs are more likely to start a new relationship with a manager via an initial deal in a joint venture. The intent is to invest on a scalable basis through a club deal or programmatic structure, once that LP has become comfortable with the initial deal or deals.

With such a structure, the placement agent will charge a “placement fee” on the initial deal, and continue to be paid for future investments made between the parties over an agreed to period of time regardless of the structure. The placement agent's role in this situation relates to their ability to match the real estate team with the appropriate capital partner, but on a more targeted basis.

Alan Bear, a principal at Probitas, says: “The private equity model isn't dead, but institutional investors are currently reassessing their portfolios, managers and strategies to determine with whom and how to invest in the next cycle.

“What has happened to the capital markets and the value of their existing real estate portfolios since last fall has been quite a wake up call,” Bear adds. “Investors are asking themselves ‘How do I best invest in what should be incredible opportunities over the next two to three years, but also protect my downside exposure?’”

Investors are asking themselves ‘How do I best invest in what should be incredible opportunities over the next two to three years, but also protect my downside exposure?

Bear says there are pockets of investors with available capital who are assessing their existing fund portfolio and opting to make new commitments to their top performing managers. But many LPs are also looking for the next set of new managers, he adds, because whoever invests in 2010, 2011 and 2012 is going to make a lot of money if they are strong, “back to basics”, operators.

Given that most funds that invested from late 2006 onwards have problematic investments, the received wisdom is that there are only a handful of well-known fund managers with the ability to spin-out and start their own real estate fund operation.

This is bad news for placement agents. First-time fund managers have been a staple fee earner for much of the industry, with many first-time funds using placement agents as a means of getting access to institutional investors and helping boost their image in the LP community. First-time fund managers also don't have the human capital to respond to the avalanche of due diligence enquiries which fall their way from prospective LPs.

Today, though, many placement agents are turning away this type of client or putting them “on hold” because of the reduced fundraising success rate.

That is not to say placement agents are completely shunning people wanting to be principals. Some agents are taking meetings and charging for advisory work on an on-going basis.

“We are currently working with and speaking to some very accomplished real estate managers that have an impressive team and track record,” says a London-based director at a large global placement agent. “However, these groups need our advice and guidance on how to best to set up an institutional real estate funds management business.” A number of placement agents PERE has spoken with are adapting their business in this way. Once the market turns, they consider that some of the fee can be rolled into a success fee later based on the distribution efforts.

Fee pressure

With the pressures facing the placement agent business, most professionals would assume the industry is cutting fees in order to win the business that is out there.

This is only true up to a point. Because it is much harder to raise capital at the moment, some agents feel they are able to maintain or even elevate their fees in certain cases.

Placement agents' fees are fairly straight forward. They charge a percentage of the equity when a fund is closed. This might be 1 percent for a “top up” assignment (when the fund manager has already raised a significant chunk of equity and are looking for additional equity to get to a pre-specified cap). Or it might be 3 percent for a fully blown project managed and distribution effort on behalf of a first-time fund.

Magnus Christensson, a London-based partner at US group Atlantic-Pacific Capital, says, in his experience, fees were edging higher towards 2.5 percent of the equity raise, up from 2 percent. He explains: “The reason is that more GPs are asking for heavy lifting support and also the competition has weakened from some of the agents at the investment banks.”

Last month, it emerged that Citi Alternatives Distribution Group was exiting the placement agent business. There are also question marks over the long-term future of a similar unit at Merrill Lynch, according to some market practitioners.

With the competition from some investment banks reducing, and perhaps the smallest firms deciding that there is no business to be had anymore, the remaining agents are hopeful they can ride out the current storm.