Established talent is being hoovered up – where are all the start-ups vying for their place?
Small real estate investment managers are becoming a critically endangered species across Europe as property investors and international fund managers across the world buy them up. Not all investments are structured as an outright buy – some acquisitions are phased through progressive stake building or by call options. All, however, seem to be motivated to ultimately achieve full ownership.
The key rationale of the acquisitions is to secure the services of entrepreneurial individuals and, in doing so, to gain access to their pipeline of deal opportunities. For these international purchasers the alternative to acquiring is the risky and time-consuming process of building a team organically with the necessary experience and track record across major European jurisdictions. To senior management with fund raising targets and/or money to deploy, the lost time of building a team is simply not a pragmatic option. After all, get one large real estate deal right and the costs of buying the team will seem minor!
International investors strongly favour buying full-service investment management platforms for their regulatory credentials and for their strong annuity income streams, as investment management services generally have long contracts and strong margins. Less favoured are the small non-regulated operator platforms providing lower-margin asset management revenues, which tend to be secured only for the business plan duration of an investment. International investors typically regard these platforms for their potential, at best, for a series of one-off asset deals.
The top targets for international investors are platforms that are both regulated in multiple jurisdictions and are well embedded into at least several major European real estate markets. Both attributes usually indicate the target is going to be immediately accretive to transaction capacity. The ability to run investment vehicles on a pan-European basis is very valuable because the reality is that, despite half a century of European integration, each countries’ real estate market is still remarkably bespoke.
While the business lifecycle of formation – and the subsequent options of failure, growth, buy or be bought – is an entirely natural commercial process, it appears that the rate of new business formation is now particularly low. New start-up businesses are simply not joining the industry at the rate they are being acquired – hence the increasing rarity. Let’s examine some of the reasons.
Lack of talent
Most new start-ups in the sector are formed by individuals already in the industry who have the experience and courage to think the potential rewards might outweigh the risks. Transfers from agencies has usually supplied such talent. However, the top ‘rain-makers’ at the big agencies have been well rewarded during the decade-long bull market so there has been little incentive to move.
As the market now turns it is likely that a combination of agency team down-sizing and lower bonuses will lead to some well-regarded agents establishing new platforms. However, given that most agent roles have become highly specialised (within a tight geographic and/or sector focus), and the hurdles to becoming a regulated investment manager are high, most of these new entrants will target becoming an operator platform rather than a full-service investment manager.
The more likely source of new investment managers are break-away teams from private equity houses. However, there have been few recent examples because, I suspect, executives are tied into very significant unrealised promote payments from favourable investments made in the last ten years.
The barriers to new businesses entering the sector have materially increased over the last decade.
These hurdles can seem daunting because of their complexity and the time it can take to clear them. Achieving the authorisations required to manage collective investment vehicles can take six months, and will require advisers and a team of three to four individuals who have appropriate experience across compliance, fund structuring and financial services.
Once approved there are regular reporting requirements, annual fees and the need to hold capital in the business.
While the FCA’s fee structure is very fair to small businesses (being levied on revenue and assets under management), there are fixed costs of compliance monitoring and reporting that disproportionately weigh on smaller businesses.
Changes in investor appetite
Over the last decade large institutional investors have increasingly focused their attention on deploying capital with fewer larger investment managers to reduce counterparty risks and streamline ongoing management. This is understandable – deploying, say, £50 million to a small manager is going to be irrelevant to the increasing number of funds that close with over £5 billion of capital raised. As one investor recently said, making €45m over three years on an opportunity I had introduced was irrelevant when they had a fund profit target from Europe of €3bn – the deals had to be bigger!
While the business logic is clear, the focus on big investment managers will, over time, dramatically reduce the manager choice.
Hope for the medium term?
While any industry can survive in the short term if new businesses are not entering it, in the long term that trend must change for a healthy industry to be maintained. I cannot see any of the above trends reversing soon – but I am at least hopeful for the medium term.
Without ‘singing my own shop’, I do believe that smaller businesses perform asset management well and can often make material co-investment that gives investors comfort by alignment. Small businesses are also often better able to avoid conflicting engagements and do not need an allocation policy between clients.
If we have seen all the yield compression we are going to get in this market cycle as quantitative easing is unwound, then asset management is going to re-emerge as the key driver of real estate performance. I therefore believe global investors will rediscover the smaller industry players with attractive track records.
In short, there might not be a better time to take up the challenge, clear the regulatory hurdles and join the European real estate investment management sector.