Meh-diocrity
We analyse the ULI and PwC 2024 survey: valuation diminution and capital raising divergences??
The much-anticipated ULI and PwC Emerging Trends in Real Estate report found a direct link between the volume of investment and the level of trust in property values. One of the most remarkable findings of the survey was that up to three-quarters of contributors think that current prices "do not accurately reflect" all the challenges and opportunities in real estate; whether it's climate change, social impact, or even basic occupier demand. In some cases, valuations are also becoming more delicate within an industry that heavily relies on generating revenue from real estate offered as a service. A pan-European investment manager notes that landlords are now embracing operational risks in a manner not historically undertaken, foreseeing it as an essential aspect for maintaining competitive performance. Some contributors describe the situation as a ‘polycrisis’ while others liken it to a “cocktail that doesn't taste good at the moment.” If we were to capture the sentiment of the report, the past year has been meh-diocre.
The increasing costs of capital for real estate are attributed to the superior returns offered by fixed-income assets. The Chief Information Officer of a pan-European real estate fund manager remarks, “We've had approximately 12 years where real estate served as a favourable alternative to bonds; now, we're entering a phase where bonds prove to be a highly viable substitute for real estate”. Some institutions are decreasing their real estate allocations in favour of fixed income, driven by the denominator effect, where slower revaluation of property compared to other assets results in a higher allocation relative to falling equity and bond values, hindering further investment. “That's going to linger over the market for longer than I think many would like” says one global institutional player. Another observes that “not only are bonds looking better as an investment, but they're also delivering the yield that investors want, and thus arguably investors need real estate less”.
Nearly half of survey respondents anticipate a decrease in capital availability for debt refinancings or new investments, while 28% expect an increase. In 2024, 65% express worries about refinancing, up from 53% in 2023 and 30% in 2022. Additionally, nearly half of the respondents are troubled by covenant and loan servicing issues, reflecting an increase from 30% in 2023 and 19% in 2022. Despite challenges, interviews suggest that additional equity sources are currently awaiting clarity on peaks in inflation and the interest rate cycle, along with the emergence of distressed buying opportunities. According to one European pension fund manager, “slowly more equity is emerging to invest because people do see that there are some interesting buying opportunities”, though not at the scale seen before the pandemic.
However, those opportunities are contingent on valuations catching up with investor sentiment, which, according to the survey and interviews, investors believe is still a long way off. Many people agree that valuations do not accurately reflect current real estate challenges and that prime assets are overpriced. The persistence of wide bid-ask spreads suggests that valuations are not narrowing quickly, with the CEO of a UK-based investment management firm noting, “valuations are too high, [there’s] no evidence, and not many are motivated to sell.”
However, some lenders are taking a more pragmatic approach, providing financing to strong sponsors who have credible plans to improve buildings in key city centre locations. Some interviewees even predict that “banks will fight for the good [assets] and price them very competitively” while another observes that “it feels like a pretty constructive debt financing market for good quality assets [if] covenants aren’t under pressure”.
领英推荐
In response to the challenging real estate market, banks are redirecting their focus towards active loan books and existing clients. Borrowers are experiencing stricter loan terms, higher rates, and increased scrutiny of asset management plans, especially concerning ESG improvements. This challenges the optimism about the availability of rising equity, as more property owners may need to inject equity into existing assets or enhance capital expenditure plans to meet impending minimum energy efficiency requirements. Survey respondents anticipate an acceleration in the shift away from traditional bond and bank financing, with more lending expected from debt funds, alternative lending platforms, and non-bank institutions in 2024 compared to 2023.
Prices are ebbing and flowing. Following outward yield movements in the third quarter of 2023, Savills now considers certain office assets in Europe to be fairly priced. The property adviser said assets in Berlin, Amsterdam, Madrid, and Munich now offer “fair value” and require the lowest capital value corrections in the region. For now though, capital is looking elsewhere. According to a Schroders institutional investor survey, only 27% of investors expected to increase their real estate allocation, while 13% expected to decrease their allocation. Private equity took the top spot, with 44% and an 8% respectively.
In the U.S., where prices have moved more quickly, allocation levels have stabilised. The 11th annual Institutional Real Estate Allocations Monitor, published by Hodes Weill & and Cornell University's Baker programme in real estate, shows that average target allocations remained at 10.8% despite economic woes, rising interest rates, and frozen transaction markets. However, investor sentiment has risen to its second-highest level since 2013, with institutions expecting to profit from dislocation and distress in the coming years. “While target allocations are flat year-over-year, this follows ten years of increases totalling 190 basis points, which represents an increase of over 20%” said Douglas Weill, managing partner at Hodes Weill “Moreover, the industry has consistently outperformed relative to target returns over the long-term”.
For now, capital raising is tough with Preqin's Real Estate Quarterly Q3 2023 update, revealing a decline in fundraising and deal flow, reaching post-COVID lows. Just over $18bn was raised across 61 funds, marking the slowest rate in the current interest rate increase cycle. Institutional investors are reducing exposure, between Q3 2022 and Q3 2023, there was a 61% decrease in closed ended funds and a 54% fall in total capital raised. North America-focused funds' share declined from 80.7% to 69.7%, with value-added vehicles leading in capital raised at $6.8bn (37.4% share).
In a tough capital raising environment some firms are struggling more than others, with two leading private equity firms, KKR and Carlyle, reporting results with divergent paths for these once-similarly sized investment groups. KKR is experiencing an increase in fundraising expectations and is expanding its infrastructure and real estate investments. In contrast, Carlyle is implementing a cost-cutting drive, including job cuts. “Overall, we have not been pleased with fundraising in 2023” Chief Executive Harvey Schwartz told analysts. Carlyle raised $6.3bn in the third quarter, an 11% decline from the previous quarter, and closed its latest flagship buyout fund with $14.8bn in assets, 20% less than its predecessor and below the targeted $27bn. KKR, however, raised over $14bn in the quarter and reported a “a noticeable uptick in our pipelines around fundraising, deployment and monetisations”, according to Robert Lewin, chief financial officer.
To be sure, some funds are booming. Connor Teskey, President of Brookfield Asset Management stated, “We had an excellent quarter from a fundraising perspective. We raised $61 billion of capital year-to-date with $26 billion of that capital in the third quarter. We closed our sixth private equity strategy at $12 billion, their largest ever to-date.” He continued, “2023 is shaping up to be an excellent year for capital raising.”
There are signs that the motivation behind the rotation into debt strategies might be unwinding. Aviva’s analysis of relative value in real assets finds that while historically debt markets have offered better opportunities than equity markets, certain equity investments, particularly in real estate, are beginning to look more attractive than debt in absolute terms. Despite the UK's weaker growth outlook, they rate UK equity investments more highly than those in Europe. However, when considering current risk-free rates, the positions reverse.
Despite this, they find that real estate debt, due to higher government bond yields and illiquidity premia, continues to offer considerably higher returns per unit of risk than real estate equity. UK real estate debt outperforms Europe, primarily due to higher gilt yields, though this picture changes when factoring in market risk-free rates. In the United Kingdom, floating-rate debt is considered more attractive than fixed-rate debt in infrastructure and real estate. The inverted yield curve, where short-term yields surpass long-term yields, contributes to this preference, as investors are willing to accept a higher all-in coupon for shorter-term debt rather than locking in a longer-term fixed rate at current levels. Despite ongoing risks, they find that the overall market outlook is gradually improving, with markets showing resilience and moving on in the absence of further negative developments.
David Rubinstein, co-founder of Carlye, in his book ‘How to Invest’ remarked that he thinks investment professionals should spend more time learning how to talk better, as many are not so fluent in communicating their thoughts. “It can be very helpful in attracting investors, attracting talent, and getting people to share information with you” he said. Investors have been unable to articulate market dynamics clearly, partly because the market is suffering from a little meh-diocrity.