For Mark Allnutt, real estate is at “a super interesting point in the cycle,” with inflation starting to tail off and GDP growth forecast to increase next year in many major economies.
His firm, US-based residential manager Greystar, has executed approximately €1.6 billion in transactions across Europe this year in rental housing and student accommodation. Perceiving a “period of calm” invoked by greater stability and less volatility in capital markets and financial markets, Allnutt expects a recovery in transaction activity in rental residential – and commercial real estate in general – could occur within a few months in Europe. He tells PERE how he expects this to pan out, and what, if anything, could derail it.
When do you expect to see transaction activity pick up next year?
It could start in Q1. There’s more certainty around capital markets and financial markets, so there’s a bit more visibility on where we’re going. Some processes have also been held back from 2023, especially disposition and recap processes. They will have to be launched in 2024, and there might be a run on those in Q1 as everybody tries to beat the market by getting their process out first.
People are also starting to accept the new cap rate environment. We’ve been at zero interest rates and super low cap rates for a long time and that has not provided any real value for purchasers to some degree. It also means a lot of refinancing needs to happen. Sellers had been waiting for cap rates to come down, but there is an expectation now that they are likely to stay elevated for longer.
People are also taking a little bit of heart from the economic signals. For example, the UK 10-year Gilt just dipped below 4 percent for the first time since May, which is good progress. That means sellers will start to feel a little more confident that they will be able to achieve a cheaper price that is satisfactory to them, and buyers will feel more confident in their underwriting. That will prompt some transactional activity through both lenses of the telescope.
The residential market has corrected to a significant degree this year, so why has deal activity not already returned?
Valuations have moved as cap rates have widened, but because potential sellers have been able to hold on and wait, there hasn’t been much in the way of transactions in the rental residential sector in Europe. But we believe that’s going to start breaking a little in 2024. Look at the markets that have had the biggest correction, such as Germany, where rental residential was trading at a sub-3 percent cap rate and now needs to be over a 4 percent cap rate – that’s a huge change in terms of pricing.
Are you expecting to see any distress?
There’ll be some distress as people have to sell. But we believe that will manifest itself in the second half of 2024. There is still some unwinding going on; asset owners are still able to push some refinancing out. But there will be a need to replace some hedging instruments, and there will be some fixed-rate debt coming to an end.
Anything that was financed in 2018, 2019 or 2020, or even before that, is going to be coming due for refinancing. These assets would have been financed at super low rates and now need to be refinanced at higher rates. Capital structures will need more capital, more equity injected, more expensive financing coming into the capital stack. Some equity can cope with that, some can’t. This means any fundraise or venture formation now with any new equity should be about to participate in a really good vintage year for new ventures.
Closed-end funds that closed in 2018 or 2019 will also be coming to the end of their lives and need to start disposing of assets. Those funds are going to be selling into a market that is very different to what they thought it would look like in terms of cap rates.
What role will the banks play in catalyzing activity?
It feels like there has already been a bit of a shift in terms of where lending is coming from. There has been a bit of a slowdown in conventional bank lending. Banks have been amenable to helping borrowers, but at some point they need to get their capital back and redeploy that into more profitable activity. Plenty of alternative lenders will step into the vacuum where banks withdraw. But it will be more expensive and that will have a big impact on valuation and price.
Residential is a popular choice among investors at present. Would the market opportunity be derailed if there was a recession next year?
Capital is coming into rental residential because the sector has proved its narrative over a long period of time as an inflationary hedge, with less volatile cashflows and NOI growth through difficult periods when other commercial real estate sectors struggle.
Rental housing typically performs well in an economic recession, because it typically means fewer people are buying homes and more people are pushed into the rental sector. It would possibly mean there would be less growth, as rental growth would taper a bit as demand meets affordability. However, rental housing has historically performed well in an inflationary environment because of the duration of the lease, and because 70 percent of cashflow is revenue, 30 percent is opex and in an inflationary environment your revenues typically grow faster.
What about the potential for another macroeconomic or geopolitical shock?
There’s always the potential for a big macro event. But the sector has proved the resiliency of the cashflows over the past 30 years through recessions, war, pandemic, high inflation. I would be concerned if there was another demand shock, however – the pandemic was a real challenge as it gave us an occupancy shock, specifically in student housing.
That said, there doesn’t seem to be anything that would slow the type of population growth we’re seeing, the urbanization we’re seeing, the massive undersupply and shortage of housing we’re seeing – which we believe is decades away from being fixed – and the propensity of the middle classes to consume world-class education in global cities.
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