Despite investors flocking to real estate in the face of a volatile stock market and low bond yields, the opportunistic real estate investment climate remains challenged for 2012. Opportunity funds are expected to further downgrade their return expectations and continue to struggle to source transactions with which to invest capital, according to the Emerging Trends in Real Estate 2012 report by PwC and the Urban Land Institute (ULI).
Harbouring significant amounts of dry powder, opportunity funds and private equity managers have been unsuccessful thus far in identifying attractive deals in order to put committed capital to work, and 2012 doesn’t look any more promising, according to the report, which interviewed more than 275 real estate experts and surveyed an additional 675.
One problem is the saturation of equity capital, with 56 percent of respondents predicting that the equity side of the market will be moderately to substantially oversupplied, given the dearth of investment opportunities. Indeed, demand for core properties has driven down yields on trophy assets to unattractive levels, while troubled assets continue to remain on lenders’ balance sheets rather than hitting the market. Ironically, a wide range of properties remain tied up in last-generation closed-end opportunity funds, the report said. While LPs have refused to invest more capital in overleveraged buildings, they also have delayed writing off those properties. Without the infusion of new capital, those assets continue to deteriorate in the funds.
Investment banks may take some funds public to raise capital and resolve debt issues, although some may exit the fund business altogether. “[Management] doesn’t see the point after recent losses, the poor outlook to score large performance fees and potential new onerous reserve requirements,” forecaster Jonathan Miller wrote in the report.
Opportunistic investors are lowering their performance expectations, with even mid-teen returns appearing unlikely as risk increases from weak supply and demand fundamentals, according to the report. “The return landscape for 2012 represents a mixed bag, and all depends on where and when investors bought, the amount of leverage employed and asset quality,” said Stephen Blank, senior resident fellow for real estate finance at ULI.
With core real estate funds unable to produce high returns, some pension funds have opted to commit more dollars to opportunity funds and non-core markets. Others are playing it safe and choosing to invest in core because such investments still are expected to yield the mid to high single-digit returns needed to meet actuarial requirements. One challenge with investing in core, however, is managers of such funds are now struggling to identify transactions because of cap rate compression.
Meanwhile, pension funds may put commitments to real estate on hold all together amid a falling stock market, which could suddenly push real estate allocations above targets. “Pension funds operate on a six-month, tape-delay basis, worrying about allocations versus worrying about today,” said one respondent. “Many go into delay mode.”