Private Equity and Sovereign Interests Converge in US Real Estate | Skadden, Arps, Slate, Meagher & Flom LLP
Take away food
- Private equity activity, both fundraising and investing, has exploded.
- Sovereign wealth and foreign government pension funds have become more sophisticated, developed in-house capabilities, and increasingly focused on real estate, and U.S. real estate is a particularly attractive asset class from the perspective of view of control, yield, taxation and diversification.
- We are seeing growing collaboration between these foreign investors and private equity firms in the US real estate market, as well as a trend towards co-investment and co-GP deals.
- As a result, real estate transaction activity in the United States is unlikely to decline anytime soon.
Private equity and real estate
After a brief slowdown at the onset of the COVID-19 pandemic, private equity (PE) deal activity rebounded in the second half of 2020, and momentum strengthened in 2021. In mid-2021, PE accounted for 30% of all M&A activity, Private equity deal volume was at its highest level since 2006-07 and there were more than $10 billion in buyouts in just any year since 2007.
In the near term, private equity activity looks likely to continue to soar. Private equity firms are estimated to have amassed $3.3 trillion in unspent capital, or “dry powder,” as of mid-2021, and fundraising continues to surge, with new funds launching in 2021 that would seek to raise more than $500 billion. Since fund terms often limit the time that capital can be deployed, we expect to see trillions of dollars invested in the short to medium term.
A significant portion of the dry powder is for real estate, seen as a hedge against inflation. According to Bloomberg, private equity funds had more than $280 billion in committed capital for real estate transactions at the end of 2021, an increase of 11% over the previous year and 57% more than at the end of 2019.
In recent years, the private equity industry has paid more attention to real estate as an alternative investment. Returns have been attractive and the asset class is attractive to investors looking to deploy capital over long periods of time. This contrasts with corporate takeovers where investments are often made in three or five years, leaving investors to find new places for their capital. Commercial, industrial, medical and life sciences real estate have remained favorite sub-sectors and more recently residential real estate (single family and multi-family) has joined this mix.
Another driver of private equity activity in the real estate industry is the general trend towards consolidation and proliferation of large real estate portfolios, resulting in large complex transactions.
Investors linked to foreign governments and real estate
While traditional investments such as equities and fixed income investments have historically made up a substantial portion of the assets held by sovereign wealth funds and foreign government pension pools (together, sovereign equities), there has been a trend over the past 10 years into alternative assets, including real estate. Sovereign equity investors typically have long investment horizons and large amounts of capital to deploy; as such, long-term investments in the real estate sector are not only attractive, but desirable.
The size, stability and sophistication of the US housing market has made it a natural place for sovereign equities to place funds for long periods. Sovereign equity investors have increased their allocations to US real estate given its strong performance, according to the Sovereign Wealth Fund Institute.
Unlike a company, where a sovereign investor can seek minority seats on the board and depends on management for crucial operational know-how, they can exercise greater control over their real estate investments, including decision rights. important and seats on the advisory board.
With increased rights, investors in sovereign equities must consider potential regulatory hurdles that may arise as a result of increased scrutiny, including interest from the Committee on Foreign Investment in the United States (CFIUS or the committee ). While unlikely to trigger mandatory CFIUS filings, real estate investments often fall under the voluntary jurisdiction of the national security regulator. With an increase in CFIUS’ proactive outreach to investors regarding transactions not voluntarily notified to the committee, the implications of CFIUS should be considered early in the investment process.
The Intersection of Private Equity and Sovereign Equities: US Real Estate
The objectives and characteristics of sovereign wealth funds and private equity firms create natural synergies between the two, especially in real estate. Private equity firms seek large amounts of capital to invest, and sovereign equity investors control and deploy huge amounts of long-term capital. Sovereign equities seek greater control over their investments, but do not necessarily want the burden of being a sole proprietor in a foreign market with little or no in-house day-to-day asset management capabilities and few local industry connections .
Real estate is one area where, by working with private equity firms, sovereign equities can achieve improved returns and greater control over investments without having to build deep operational teams or manage other issues. created by direct investment. Private equity firms provide industry expertise, operational support and access to relationships, while sovereign equities can provide large amounts of capital that allows private equity firms to act quickly when opportunities arise. , without the pressure of deadlines to put the capital of the funds to work. Working with PE managers can also mitigate other issues associated with direct investment by foreign entities, such as national security reviews. For these reasons, sovereign entities have mostly played a largely passive role, investing as sponsors in funds.
However, as the relationship between sovereigns and private equity firms develops, they sometimes become not only co-investors but also co-GPs, with sovereigns taking stakes in sponsors and the asset managers they invest with, giving foreign institutions up and down potential. costs. As a co-GP with third-party LPs, Sovereign Equities can share interest carried and management fees. It is no surprise that many sovereign investment institutions now have, or are developing, sophisticated internal and legal teams capable of underwriting and executing transactions.
As sovereign equities have become more sophisticated and develop more in-house talent, we are likely to see them collaborating more with private equity firms, especially in asset classes like real estate where both parties can easily achieve their Goals.