Tough calls: Property fund management has, of late, turned into something of a minefield. Can managers find a safe way through it? Mike Phillips reports
Last month, two property fund managers went public about problems in their funds. Tilney Asset Management, a division of Deutsche Bank, manages a £1bn property fund for the man on the street Carlyle Group manages billions of pounds for the world’s largest institutional investors. The collapsing property market is affecting the beggar and the king.
The cash call from Tilney’s £1bn Glanmore Property Fund was announced in a terse statement to the Irish Stock Exchange, on which the fund is listed. “In light of the continuing economic circumstances adversely affecting the performance of the company,” Glanmore said, “the board of directors is in discussions on plans to raise further capital for the company. The company has been holding discussions with a number of parties including its lenders, and is considering a number of proposals.”
The fund has already cut its dividend payout in order to preserve cash, and is now seeking more equity, primarily to avoid breaching loan-to-value covenants. The fund is rare among those targeting private investors, in that it carries debt. Last year it asked investors, who are unable to take out their money because of a bar on redemptions, to extend internal loan-to-value covenants from 65% to 75%. A cash-raising proposal is expected to be agreed within the next two weeks.
Debt is also the focus of Carlyle’s problems. Last month, it said that it had been unable to refinance a £17m loan secured against an office building at 11-15 Monument Street, London EC3, and will default when the loan is due to be repaid in April. The default means that the redevelopment scheme Carlyle is backing – the dramatic new “Concertina” building designed by Ken Shuttleworth – has been put on ice indefinitely.
Managers’ new world
It is indicative of just how tough the market is that a fund manager as large and well-regarded as Carlyle is having trouble refinancing a £17m loan, which is secured by an income-producing property. But this is the new world for fund managers.
“We’re in discussion with Hatfield Philips [the loan servicer] as to what is the best way forward,” said Robert Hodges, Carlyle’s managing director of European real estate. “Because of the way the markets are, we can’t go out and refinance, which is how we would normally pay back a loan.”
Indeed, some industry figures foresee more problems for the huge funds backed by billions of pounds of institutional cash and run by the likes of Morgan Stanley Real Estate, Blackstone and Carlyle. This is partly a result of the fee structure of private equity fund managers.
Discount for size
“These guys have relied on the ability to deploy the huge amounts of cash they can raise,” says Peter Kasch, managing partner of fund manager Catalyst Capital. “It used to be that you got a discount for size if you were taking on a large transaction.
“These large transactions created very large fees, as managers are often paid fees for acquisitions and disposals. It isn’t possible to do those mega-deals any more because there isn’t the debt to fund them, and this leads to an obvious reduction in the fees available.”
Kasch says that many fund managers take a basic fee for asset management, often 2% of a fund’s total size, and also a “carried interest” if returns exceed a certain benchmark. This later fee can often be as high as 20%, and is where a fund manager makes most of his profit.
To illustrate this, Blackstone, one of the few listed private equity fund managers, said last week that in its Q4 results, its staff made a loss on payment of £12m because previously earned carried interest was clawed back.
“A lot of fund managers in general are realising that funds they set up in the past five years aren’t going to make any carried interest,” Kasch says. “One friend of mine said that the only reason to carry on managing his fund was to maintain his reputation, as he wouldn’t be making any money on it.
“There is only so much incentive when you aren’t making any money on a fund you are not going to go that extra mile to work an asset for your investors.”
The drop in fees is leading to an obvious contraction in the industry. The subsidiary of aAIM that managed a €2bn fund for Bank of Scotland Corporate was put into administration last December because of a lack of working capital. Its fee structure was heavily weighted toward acquisition fees the fund – Britannica Shopping Centre Fund – got paid when it bought assets so, when deals dried up, so did its income.
Even large and well-established funds are having to reduce staff numbers because of reduced income. LaSalle Investment Management saw its operating income fall by more than one-quarter to $82m, primarily due to a drop in performance fees and earnings on the equity it puts into its funds. As a result, it has had to reduce total staff numbers by 7%.
PRUPIM, the UK’s largest property fund manager, also cut as many as 20 staff – around 7% of its headcount – last month.
So what do investors think of these issues, and how are they working with managers to solve them?
“The easiest thing is to cancel the dividend or distribution,” says Nick Cooper, global head of ING Select, ING’s property multi-manager business. “That isn’t great, but it is an easy thing to do. Then there is selling properties, but that is not an easy scenario, as selling into a falling market can exacerbate the problems.”
Cooper adds: “If there is a convincing argument, then we will put in more equity. But then other questions arise, such as what is the price of the equity you put in, and what happens if not all of the investors agree? There is a whole raft of these sorts of conversations going on at the moment.”
Investors and managers alike, at whatever level of operation, have a tough few Mondays ahead – and they might not even be getting paid for it.
Shifting to another gear
An increasing number of property funds are facing a problem of their own making – internal gearing limits. These are strictures put in place by funds at their inception indicating to investors the maximum level of gearing they should take on. And, as values drop, they are increasingly coming up against these limits, and needing to find restructuring solutions.
Richard Rawlings, manager of Grainger’s G:res fund, which was close to its limit, says: “We’ve had a dialogue with our [13] investors, and they’ve agreed to change the articles of association of the fund so that the gearing threshold goes from 65% to 75%, in line with our banking covenants.
“I think they are relaxed about this. There was no change in fee structure in return for this move.”
However, with residential values likely to continue to fall, Rawlings needs to ensure that the fund does not breach its banking loan-to-value covenants when they are next tested in June, and is seeking innovative solutions.
“We are selling assets, as there is still a liquid market for the blocks and the individual assets which make up our portfolio,” Rawlings says. “But rather than just using that cash to pay back debt directly, we have been in negotiations with our syndicate of banks, and it will be kept in a separate account. This will be taken into account in the value of the fund when the covenant is next tested in June.
“But we can still access the cash if we need to, when the market improves.”
Ian Whittock, chief investment office at ING Real Estate, says: “We are trying to recapitalise. We started with gearing of sub-50%, which we thought was prudent now, it is north of 70%.
“If you’ve got gearing issues because of the extent of falls in the market, and those falls are going to be maybe 50%, really everyone is going to have issues.
“Britannia has got plenty of income in it, but it is very difficult to value anything. Banks are not set up to manage all this property where the income cover is comfortable, they seem to be prepared to work things through.”
He concludes: “If we get new capital, it gives you quite a strong negotiating hand with the banks. So, yes, we are looking at a recapitalisation. We are looking at ways of keeping ahead – and that means looking at either recapitalisation, new investments or selling properties.”
