Investors take stock as activity levels decline

Institutional investors’ appetite to commit to real estate funds becomes muted in a volatile macroeconomic environment, says James Jacobs, head of real estate for Lazard’s private capital advisory group

James Jacobs

Figures from October reveal a substantial decrease in investor appetite for real estate funds, marking a sharp decline in activity levels over the past three months. Real estate fundraising fell by more than 25 percent in the first nine months of 2022, according to PERE data, amid continued equity market volatility, fears around economic growth and geopolitical uncertainty. Interest rate hikes and increases in financing costs have led to the expectation of valuation declines which, combined with a lack of transactional evidence, has presented underwriting challenges.

Many equity market indices globally hit new lows during the third quarter of 2022, causing imbalances within institutional investors’ private portfolios. Volatility, as evidenced by upward spikes in the VIX index in October, is adding to the uncertainty. The worsening denominator effect has led many investors to move to the sidelines as they are unable to commit to further private investments.

Additionally, interest rates have risen by over 300 basis points in 2022 alone, with 30-year US mortgages hitting their highest levels in 20 years. Although a rise in interest rates had been anticipated, the velocity of the latest hikes, coupled with expectations of further increases and pull-back of debt from financial institutions, has concerned many market participants. While real estate valuations are expected to decline on the back of rising financing costs and weaker economic growth, the extent of impending write-downs remains unknown. This raises questions for investors as to the benefit of committing capital at current values, rather than waiting to acquire assets at expected lower future values.

In addition, the direct market has not provided a wealth of guidance, as Q3 transaction volumes are down almost 40 percent from the first quarter of the year. Bid-ask spreads are widening, with many buyers exiting sales processes or being unable to meet pricing expectations. Thin trading data and little price discovery by sponsors on the front lines means institutional investors have little guidance for underwriting seed portfolios or business plans.

Despite reduced activity and appetite for new commitments overall, real estate credit does offer a bright spot for investors in the current environment. Short-duration floating-rate debt strategies continue to generate income and have seen returns trend upwards with rising rates. This shift in appetite is set to continue until investors gain better clarity on pricing and valuations in other areas of the real estate investment market.