For those investors that are active in deploying capital, one of the biggest shifts we have seen in 2023 is an increased appetite for risk. Investors globally appear to be moving up the risk curve; 70 percent of the investors we spoke to during Q1 are seeking higher returns. Given widespread industry concerns of distress driven by more persistent inflation, increased interest rates, falling valuations and, most recently, bank failures, it is no surprise investors are seeking a premium for committing capital today.
Several investors expect distress in the real estate market to materialize and gain momentum. The repricing of credit, falling valuations and lack of bank financing have left many asset owners facing refinancing issues. Real estate credit funds are seeking to step into distressed situations where borrowers now find themselves breaching covenants, overleveraged or unable to refinance with traditional lenders. With year-end valuations becoming available, investors are beginning to see the first wave of distress, with an expectation that the worst is yet to come.
“Significant repricing; very compelling opportunities to buy at a discount”
Asian family office
Following a pause in Q4 2022, real estate secondaries and recapitalizations are now starting to transact as seller expectations adjust to prevailing market pricing. Deals are trading at substantial discounts to 2022 valuations, with sellers including open-end funds, listed REITs and pension funds unable to refinance or requiring liquidity.
Investors are also looking to commit primary capital with opportunistic managers that have a cycle-tested track record in distress and a proven ability to create returns in times of volatility. We are observing this across all sectors, but the most notable discounts today are in those with accelerated obsolescence such as office and retail. However, many investors are underwriting sectors with strong fundamentals such as logistics, residential and healthcare. In these segments, investors can now gain exposure at an attractive entry basis relative to 12 months ago.
“Increased cost of financing; creating distress with owners who took on too much debt”
Price discovery remains challenging given the ongoing volatility and uncertainty over interest rates. As a result, many investors prefer closed-end, blind-pool funds where they can lean on the expertise of the manager to make the decision on timing and pricing during the investment period. We have noticed an uptick in activity from investors underwriting funds, determined not to miss what could be an unparalleled vintage.
James Jacobs is head of real estate for Lazard’s private capital advisory group