2024 so far: challenges in private markets
For those monitoring real estate investment in this year’s dynamic landscape, this article is a pertinent read. In this report, we will analyze broad market factors to gain insights into how they affect current real estate investment sentiment and fundraising.
Private markets are at a particularly interesting turning point as we progress through 2024. The ongoing challenge of the U.S. Federal Reserve (Fed) to curb inflation, geopolitical unrest, fears of an impending wave of corporate bankruptcies, and waning consumer sentiment make the allocator's playbook filled with uncertainty entering the new year.
Key facts affecting the investment market this year:
- The new interest rate regime prompts a review of portfolio construction as compressed risk premiums have become a consequence to a period of low and declining interest rates.
- Long-term U.S. Treasury bond yields have changed (now ranging between 3.5% and 4.5%, according to Pitchbook).
- This has resulted in a readjustment in required returns for risk assets, causing typical portfolio optimization performance targets for institutional investors to shift from 7.0% to 9.0%, (as cash fell out of favor).
- Credit conditions are tightening, leading to a decline in transactions, impacting the exit environment and reducing distributions to Limited Partners (LPs) of private funds.
- The pace of new commitments across all asset classes of private funds are slowing due to the lack of cash returns from existing funds.
- Despite the enthusiasm surrounding generative AI in VC, there is a reassessment of valuations.
- Leveraged buyout (LBO) models are grappling with the highest cost of capital in over a decade.
- Within real estate, the office property market is in the early stages of a recession.
Still, there are opportunities…
The U.S. economy recorded a robust real GDP growth of 5.2% annualized for 3Q23, the strongest outcome since 2020. The fight against inflation has borne fruit so far, and the Fed is expected to begin reducing rates this year, given the recent weakness in the labor market. With the most aggressive tightening cycle in decades likely in the rearview mirror, the odds of a recession have decreased throughout the year, and the pessimism in public markets in 2023 has given way to cautious optimism in 2024.
Real estate investment: market overview
As reported by IPE Real Assets, the fundraising activity in the United States real estate investment sector witnessed a significant decline in the first half of 2023, totaling $66.8B compared to $159.5B during the same period in 2022. This drop was attributed to a challenging fundraising landscape, with only 87 funds successfully securing capital for real estate projects, a stark contrast to the 476 funds that achieved this in the previous year. Noteworthy is the closure of Blackstone Real Estate Partners X in 2Q23, marking the largest closed-end private real estate fund ever raised at $30.4B.
Experts predict a recovery in real estate investment
In their most recent real estate report, Preqin experts contend that elevated interest rates will persist as a deterrent to fundraising and real estate transactions throughout 2024. Simultaneously, they outline a shift towards opportunistic and distressed strategies, emphasizing the need for small fund managers to adapt to the changing environment.
The Global Preqin 2024 Report on Real Estate is an analysis of the latest fundraising, AUM, and performance data, coupled with responses from in-depth investor and manager surveys. It offers unparalleled insight into the trends shaping today's real estate investment landscape. Here are a few highlights:
- Fundraising for private real estate funds declined until the end of September, with 306 funds closing (less than 45% of the total number of funds closed in 2022).
- Capital raised in the first three quarters of 2023 amounted to $107.7B, representing 56% of total capital raised in 2022.
- Due to higher interest rates, deal-making was subdued in the first nine months of 2023.
- As more funds compete for capital in a challenging fundraising environment, this decrease in fundraising and fund closures can be attributed to market saturation.
- A total of 2,918 real estate deals were closed during this period, valued at $88.8B. According to Preqin's data, this represents 42% of the deal closures and 35% of the deal value in 2022.
- The number of real estate funds in the market increased by 27% from the beginning of 2023 to the end of the third quarter.
There was a slump in real estate fundraising in 2023, but Preqin predicts a recovery in 2024.
Large funds shifted focus from smaller ones, but..
In terms of fund size and investor preference within real estate investment, the top 10 funds closed in the first three quarters of 2023 accounted for 50% of the total capital raised. This marks a significant increase compared to the previous year when these funds represented only 25% of the total.
Preqin's research found that, despite higher interest rates putting pressure on real estate fundraising this year, larger funds have benefited overall. The straightforward explanation is that macroeconomic-driven fears have led investors to seek security in larger funds. This inevitably hinders "first-time" funds. During the first three quarters of 2023, first-time fund managers raised $2.8B, a substantial drop compared to the $15.2B raised throughout 2022.
Small funds should not be underestimated
Having said that, analysts at Preqin also found that smaller and first-time funds may have been underestimated by investors. Through September 2023, first-time real estate funds surpassed the median benchmark for their respective strategies, when analyzing funds of all sizes.
For instance, between 2014 and 2016, first-time funds in North America achieved a median net internal rate of return of 18%, more than five times that of value-added funds in North America . However, they also exhibited a higher degree of performance dispersion compared to more experienced funds. This indicates that while first-time funds have the potential to outperform, they also come with higher risks and uncertainties.
Office sector in real estate investments
Real estate in the office sector varies by regions. Experts found that the office sector played a key role in driving different real estate investment trends in North America, compared to Europe and Asia-Pacific. The sector experienced a significant decline in transaction volume in North America, totaling $8.6B in the first three quarters of 2023, just over a quarter of the $31B total in 2022. In contrast, office sector transactions in Europe and Asia-Pacific represented a larger proportion of the total deal value, 40% and 29% respectively, by the end of the third quarter of 2023 compared to 2022.
How Finalis can be your ally for real estate investments
Stakeholders diving into the 2024 real estate investment should stay agile, using market insights, adapting to change, and recognizing smaller funds' potential. Success requires a balanced approach to risk management and seizing opportunities amid the evolving investment landscape. Connect with us to explore how you can access an ecosystem brimming with up-to-date information and opportunities for impactful real estate deals. At Finalis Connect there are already 210 real estate deals to explore and over 100 real estate experts to contact.
Stay tuned as we analyze top real estate investment and deals, influential investors, and emerging trends in our upcoming article.
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