High Asset Values Making it Hard for Opportunistic Investors to Deploy Dry Powder
Buoyed by the strong increase in property values in recent years, 82% of private equity and institutional investors expect to commit at least as much capital to real estate in 2016 as they did last year, according to institutional investors surveyed by Preqin for its 2016 Investor Outlook: Alternative Assets report.
In addition, 53% of investors are below their strategic targets to real estate and many expect to increase their targets in the medium-to-longer term.
There is a problem, though. It is becoming increasingly challenging to deploy that raised capital, with high asset valuations cited as a primary concern, according to analysts with Morgan Stanley Research. As a result, capital raised to invest in U.S. commercial real estate continues to pile up, leading to record amounts of dry powder.
“This is a double-edged sword that highlights the rising risks of record-high prices while the capital that ultimately needs to be deployed may serve to partially mitigate the risk of falling prices.” Morgan Stanley analysts wrote in a report entitled Mo Money Mo Problems.
There is ample capital to invest: $107 billion of capital was raised in 2015 to invest in U.S. CRE and funds now have a record $231 billion in dry powder available to invest. Value-added and opportunistic funds raised the most capital in 2015 (about $75 billion combined), shifting away from the core strategy of prior years, according to Preqin and Morgan Stanley.
However, with that much money challenges arise. For starters, demand across all CRE property sectors remains well below the last CRE peak in 2007, according to Morgan Stanley analysis of federal data. Demand here is measured by investment as a percent of gross domestic product (GDP).
Office and retail investment are near their lowest percentage levels since the late 1970s. Demand for multifamily structures is comparable to early 1990 levels, at around 0.3% of GDP. Those numbers though are on the increase across all property types (aside from retail), with office and multifamily leading the way, Morgan Stanley noted.
This increasing outlay is coming seven years into the economic recovery – one of the longest periods of recovery on record. Invariably, some investors wonder how long the up cycle will last.
“There is an increasing lack of consensus in the market as the percentage of investors that have a positive view on the market has risen, but 12% now express a negative perception compared to none the year before,” Morgan Stanley noted.
The vast majority (68%) of surveyed institutions cited valuations as the primary concern in 2016, while performance (30%) and deal flow (27%) were noted as other considerations.
Source: CoStar Mark Heschmeyer March 23, 2016