In a volatile economic climate, private equity investors are becoming more and more selective when it comes to where to put their capital.
According to investment data firm Preqin, these investors raised a record $ 287.8 billion in commercial real estate acquisitions last year, up 11% from 2020 and 57% from 2019. , This trend may slow in 2022.
David Bitner, Vice President and Head of US Capital Markets Research at Cushman & Wakefield, said: “If I were betting, I think there would be more price adjustments.”
According to Bitner, at the beginning of 2022, private equity investors focused primarily on the popular housing and industrial sectors, along with core offices and retail assets. Industries and apartments are still attractive asset classes, but Bitner said investors are for long-term investments given the uncertainty about where rents will land in the future and the potential for higher cap rates. He said he could be much more cautious about developing capital.
Ian Ross, founder and principal of real estate development and investment firm Somera Road, has been actively seeking opportunities to suffer since it was founded in 2015. Of the market and real estate sector.
“There is a lot of fairness in the system, but that fairness is very selective, especially because there is no leverage there,” Ross said. “The availability of leverage in the market has diminished significantly, and buyers who rely on bridge finance for acquisitions require high-cost, unleveraged debt fund money, or increased equity investment. There are only limited options, such as bank financing, and acquisition financing is difficult, but larger mine can result in refinancing of highly leveraged real estate debt that matures in the short term. “
Currently, the major reason for the diminishing leverage opportunities for borrowers is the weakening of the secured loan debt (CLO) market, which currently has little source of funding. Widening credit spreads in the CLO and commercial mortgage-backed securities (CMBS) markets have made warehouse lenders more selective and private equity investors, according to Bart Clauch, Head of North America at Invesco Limited. It has a carryover effect.
“The cost of leverage will rise significantly, reducing the ability of borrowers to pay their assets and further emphasizing debt repayment coverage,” said Klauchi. “Assuming that funding costs rise and target returns do not change, asset prices should adjust accordingly in the medium term.”
While credit status can pose potential challenges for the CRE market, Klauch pointed out that there is still plenty of dry powder unleashed on the private-equity side, which could offset the looming pain. ..
“You are still looking at a fair amount of capital that is a bystander who needs to invest in commercial real estate,” Klauch said. “But the denominator effect is an oncoming headwind for institutional investors and needs to be taken into account by the end of the year.”
The denominator effect occurs when the value of an investor’s private equity portfolio exceeds the target allocation due to a decrease in other factors.
Market distress is on the rise, with investors motivated by the distressed real estate assets. Debt is also emphasized. Last month, an affiliate of BH Property acquired a four-story retail complex on 100 Lincoln Road in Miami Beach from the Vornado Realty Trust for $ 96.3 million. That’s 29% less than the REIT giant paid for real estate in 2012. A million bad real estate funds took advantage of this opportunity in July 2020 after Vornado defaulted on a $ 83 million loan in 2021.
The pain was also talked about in the Innovo Property Group’s struggle to buy HSBC Tower on 452 Fifth Avenue from PBC USA for $ 855 million. This funding was not scheduled by the May 16 sale deadline. HSBC, which accounts for 63% of the tower, has confirmed that it will not renew its lease when it expires in 2025 and plans to relocate its US headquarters to The Spiral at Tishman Speyer in Hudson Yards instead. PBC purchased a building from HSBC for $ 330 million in 2010 and currently has $ 378 million in assets.
However, Ross pointed out that the distressed CRE market also creates opportunities for basis resets for certain assets such as offices and retail stores.
“These resets can certainly open up options for rethinking the use of the property through creative changes in use, or by having to achieve lower rents than the current one, the property is current. It can be made more competitive in use, “Ross said. “There is an opportunity to acquire assets to new standards and reinvent them for alternative uses, whether it is an office to apartment building or various other transformations.”
Alfonso Munk, Chief Investment Officer of Hines’ Americas, seeks opportunities for investors to withstand recessions, primarily multi-family, industrial and self-storage, in today’s volatile market environment. Said. He said that considering how debt terms have changed over the last three months, investments that do not rely on aggressive growth assumptions or cap rate compression, and investments that do not depend on financial leverage are important. rice field.
Munk invests in needy assets such as office buildings in major gateway cities due to the many unknowns with remote working tendencies and the lack of actual trading activity that makes price discovery more difficult to measure. I warned against the house chasing. He said patience is important because many of these properties have long rental periods.
“Many investment products are expected to hit the market, so patience and focusing on quality assets in the right place is the right strategy,” Munch said. “Distressed assets are distressed for some reason.”
Pamela West, senior portfolio manager at Nuveen Real Estate Impact Investing, said investors are beginning to focus much more on the risks associated with individual transactions given the high debt costs amid inflationary pressures. They are also reassessing their ability to achieve the required rent and occupancy growth. This has led to a focus on high performance sectors such as apartments and industry.
West added that geography is becoming more important in deciding which transactions to undertake. Larger markets with strong economic fundamentals are prioritized.
“There is a new focus on location as we expect more widespread distribution of performance between strong and weak markets,” said West. “The importance of geography was less pronounced during the post-COVID blockade. It’s back.”
Private equity investors are facing the extraordinary market conditions of simultaneous strong headwinds and tailwinds, Bitner said. Investors refined their cash flow growth during the typical period of volatility, but Bitner is also at risk with this strategy as sectors such as apartments and industry are at risk of high interest rates. He pointed out that it could turn out to be.
“If COVID-19 was in a normal recession, we would now move to prime-time, value-added opportunistic activities,” Bitner said. “But it wasn’t a normal recovery, it was billed very high by the government, and now we’re inflated for a variety of reasons. And now, the recession is very significant in the next six quarters. It will make it difficult for investors to move in earnest because of the risks. “
Andrew Cohen can be reached at [email protected]..