If 2009 was the worst of times for real estate investors, what will 2010 be like? Will the bloodbath of falling property valuations continue for much of the next year or will only a select few markets start to see some form of recovery? Will deal flow remain at a trickle and will credit ever return in any real form?
As LPs and GPs balance the need to nurse legacy assets while preparing for the next opportunity, PERE offers 10 predictions for commercial real estate in the coming 12 months.
1. Foreign influx: After years of being largely priced out of mature markets, such as the US and UK, foreign buyers will start to refocus their efforts to pick up prized core assets with cash flow and real yield at opportunistic prices. In the US, commercial real estate prices are expected to reach some sort of bottom by mid-2010.
2. Opening the deal flow tap: Transactions globally will pick up dramatically in 2010 after falling more than 72 percent from their peak in 2007. Although transaction volumes won’t top 2007’s record $1.24 trillion level, more property will trade hands in 2010 than 2008. Asia will continue to lead the pack in the first half of the year, but the US, UK and other developed markets will pick up speed during the second half.
3. Calling time: 2009 was marked as a year of pretend and extend, with banks and financial institutions largely unwilling to take back real estate, mark down loans or sell at market clearing prices. However, successful attempts to bolster the balance sheets means many banks now have some capital flexibility to start addressing their own legacy assets. But only slowly.
4. Slicing and dicing: Coupled with improving bank health, the commercial mortgage backed securities market will start to creak into life – and not necessarily with the help of government financing. As the sun set on 2009, a handful of deals proved successful. That will continue in 2010, albeit only CMBS issuances secured by the best assets, in the best locations and with the best sponsors will thrive.
5. Costs of business will increase: Being a private equity real estate firm will become more expensive. Firms will need to hire more people and pay for more services to stay on the right side of a new raft of rules and regulations around the world. Taxes on carried interest, capital gains and personal income will make private equity real estate less lucrative, but for those who succeed, still highly enriching.
6. US public pensions will fade as a source of capital: These institutions remain important, but strict new rules will make accessing their capital more difficult. Many will begin to convert to defined-contribution plans, which will further interfere with traditional modes of fundraising.
7. A voice and a vote: Large institutional investors will look increasingly to direct, separate account and club deal investing in 2010 as they seek greater control over investments. For those without such heft in the marketplace, though, commingled funds will remain the vehicle of choice – with amendments. 2010 will be a year in which LPs start to pull back power from the GP, not least in areas surrounding GP discretion and perhaps even on the contentious issue of “no clause removal”. Whether those powers would ever be used, only time can tell.
8. Skin in the game: As LPs start to realign themselves with their fund sponsors, institutional investors will start to call for great co-investment from their GPs. After a decade in which GP co-investment was reduced to nominal levels, LPs will insist their fund manager put up a meaningful portion of his or her liquid net worth so potential losses – and gains – are shared by all parties.
9. Returns will come down: Leverage may have helped juice returns on the way up to the peak of the market, but it certainly helped bring them down in the trough. With little credit available today, investors are faced with closing deals all-equity or with historically low loan-to-value ratios – and lower rates of return. The era of consistent 20-percent-plus returns is officially over.
10. Back to basics: Okay, this is a repeat from our review of 2009, but it’s one that is worth making. To say that real estate investors lost sight of fundamentals during the height of the market is perhaps the understatement of 2009. The age-old principle of real estate being an income-producing investment and a hedge against inflation was largely forgotten as capital gains drove investment decisions from Houston to Hyderabad. However, as investors look to 2010 real estate has come back to its core values, in that cash flow is king. Even given the lack of transactions taking place globally, there were repeated stories of (small) bidding wars taking place for solid, quality assets with existing cash flows in place. Real estate, as many veterans have proclaimed, is back to basics. That is, until the next bubble emerges.