The pandemic’s impact on US real estate fundamentals and capital flows will reverberate into 2021 and beyond. Tenant delinquencies, rising vacancies and falling transaction volumes have caused upticks in financial distress across property sectors, especially in office, retail and hotels.
Despite elevated risks, pandemic-related financial distress looks to be short-lived. Unlike the global financial crisis, capital market liquidity has not been a problem. Debt markets are deeper, more sophisticated and – other than a brief seizure in March and April – have remained open. Real estate is awash in capital, with investment managers sitting on $353 billion of dry powder, according to Preqin data, thereby limiting the prospects for serious pricing dislocations.
With a recovering US economy and low interest rates, real estate’s income and diversification benefits become more attractive to investors. Real estate also offers a potential hedge against rising inflation, providing current income at a premium over market interest rates as well as the ability to pass price increases to tenants in the form of higher rents. Institutional investors’ target allocations should continue to expand.
Fundraising volumes therefore look poised to rebound strongly as travel and in-person meetings resume. Real estate is a relationship-driven business, which has made raising capital during the pandemic difficult, particularly for emerging managers. Preqin data suggests that first-time funds raised only $4.7 billion in 2020 – the lowest level since the GFC.
While this picture should improve in 2021, we expect fundraising to remain competitive and continue to favor incumbent managers. According to GCM Grosvenor, only 34 percent of emerging manager funds reach a final close. Manager differentiation and specific competitive advantages are therefore key to emerging managers’ success.
Creative use of technology in the investment process is one potential avenue. Funds targeting niche property types, such as data centers, medical office or life sciences, often succeed by offering investors additional diversification. Given this competitive landscape, we are seeing more managers pursue alternatives to blind pool funds. Portfolio recapitalizations are growing in popularity. More institutional investors see recapitalizations as an opportunity to acquire a specified portfolio of assets, reducing blind pool risk. For investment managers, they offer a way to secure new institutional partners, crystalize gains and inject fresh capital for the next phase of a property’s business plan.
Diversity, equity and inclusion
We all know about ESG. To that framework we now add DEI, which will be a major focus for institutional investors. Like many US economic sectors, the real estate industry’s senior leadership is less diverse than the general population. After 2020’s unrest, calls for more equal representation are leading to action.
We’re seeing more institutions adopt new manager selection criteria to reward commitments to DEI. Organizations that promote real estate job opportunities for underserved demographics, such as Sponsors for Educational Opportunity, are also seeing their memberships grow.