Investment Activity Could Center Around B and C Locations and Higher Risk and (Potentially) Higher Yield Opportunities
Private equity funds have entered the new year with record amounts of dry powder to deploy into commercial real estate. The problem is the large amount of money is available to spend at the same time they have gotten pickier about which properties and markets in which to invest.
The total level of capital available to fund managers has been climbing over recent years, from a low of $136 billion at the end of 2012 to $237 billion at the start of this year, according to Preqin, a leading source of data and intelligence on the private equity industry.
“With so much capital directed toward real estate investment globally, managers face high levels of competition for the few deals that come on the market,” Mark Grinis, global real estate fund services leader for accounting firm EY, said in his 2017 outlook. “And yet… there are many in the market who would question whether real estate is now starting to head toward its 8-year nemesis known as the real estate cycle.”
This sense that real estate may be in the late stages of the cycle could prompt some slowdown in investing and new fundraising, Grinis noted.
The latest CoStar COMPs sales volume totals also reflect a sense of caution. Equity funds slowed their buying volume last year compared to 2015, buying about $37.5 billion in 2016, down from $67.5 billion in 2015. And while fourth quarter sales data is still being collected, it’s not likely there is $30 billion of deals still to be found.
At the same time, equity funds also slowed their selling last year, posting about $32 billion in property sales so far in 2016, down from about $50 billion in 2015.
In 2017, equity fund activity looks set to center around B and C locations where they see greater opportunity to generate expected returns, EY forecasts.
The Southeast US, EY noted, continues to see population growth, with some companies setting up headquarters in lower cost locations such as Atlanta, Miami, Charlotte and Texas. Development and redevelopment activity in office, retail and hotels remains steady, providing opportunities for investors well plugged into these areas or for those seeking joint ventures, EY said.
Other secondary cities of Seattle and Dallas also remain on the radar for some managers, EY added.
The Deloitte accounting firm outlook forecasts that global private equity real estate fundraising will potentially slide as fund managers’ focus on deploying existing funds.
As a case in point, global fundraising declined 24.5% year-over-year in the first three-quarters of 2016 to $74.2 billion, possibly due to funds’ focus on deploying their existing dry powder, Deloitte noted.
Transaction activity could continue to decline and upward momentum in pricing is likely to slow down due to modest economic growth and ongoing political uncertainty, the firm said.
Despite the challenges, fund managers remain confident about deploying their capital into niche sectors, such as student housing and health care real estate, Deloitte said.
The spending in 2017 is likely to come from fewer fund managers as the bulk of dry powder is concentrated among larger players, Preqin noted. 2016 set a record for the lowest number of funds closed since 2009 (211), and represents the fourth annual decline in fund closures, down from a peak of 311 funds that closed in 2012.
Value added and opportunistic funds remain the largest part of the real estate sector, with a significant amount of investor capital seeming to move up the risk/return curve, seeking the potentially greater returns offered by higher-risk vehicles.
Core and core-plus vehicles saw fundraising fall in 2016, securing a combined $11 billion, down from $14 billion the year before.
Pricing for prime assets appears to be impacting investor demand for core and core-plus strategies, with fundraising falling in 2016, Preqin noted.
In contrast, debt fundraising has increased, perhaps reflecting investor appetite for reliable income and a substitute for fixed income investments.
Source: CoStar Mark Heschmeyer January 18, 2017