Trends in real estate private equity for 2016
Our report this year finds that fundraising is up and real estate investors are seeing opportunities in markets across the globe, including ones that have seen slowdowns. New sources of financing are emerging in markets such as Israel, and the industry is innovating to provide investors and fund managers with liquidity.
At the same time, the real estate industry is going through a phase of institutionalization as it formalizes processes, outsources noncore activities and takes proactive steps to managing increased regulatory oversight.
A new environment for real estate fund managers
With a rate rise on the horizon in the US, and a slowdown in China that some fear may destabilize its real estate market and affect both developed and emerging economies, the rising tide that had previously lifted all real estate boats over the last several years seems likely to recede.
The counterweight to these concerns is that many local economies are showing slow yet steady growth, and real estate supply and demand are in relative check, in part because that growth did not lead development to overshoot the needs of industry and commerce. The cycle is clearly turning, and the successful investment strategies of yesterday may not suit the conditions emerging today.
Regulatory reviews, compliance and exams
The challenges brought on by a nearly 50% increase in registered investment advisers since the implementation of the Dodd-Frank Act required the Office of Compliance Inspections and Examinations (OCIE) to consider both tactical and strategic opportunities to examine higher-risk registrants and, within those examinations, focus on high-risk compliance areas.
Going forward, it is clear that more and more private fund advisers will receive greater examination scrutiny. But the consequent potential for decreased systemic risk and increased confidence on the part of investors and counterparties will be a significant benefit for the industry as a whole.
Taxing times ahead
The OECD’s project on base erosion and profit shifting (BEPS) may have been originally intended to tackle real and perceived tax avoidance by multinational companies, but its effects have rippled through to the real estate fund management industry.
The risk for any international business, including real estate firms, is that different approaches by individual countries create a highly complex and constantly evolving tax landscape. Even where legislative changes are not made, it is fair to assume that governments, under pressure to increase their tax bases, will tighten up the enforcement of their existing rules.
The last 12 months have seen a clutch of public-to-private deals led by private equity real estate managers. We expect the trend to continue, thanks to rising levels of dry powder among real estate funds, some attractive pricing for the REIT sector and shareholder activism.
The attractiveness of the sector to buyers stems back to actions taken by REITs following the downturn. Many REITs took advantage of a high level of available and lower-cost capital to refinance and clean up their balance sheets. In addition, many sold off assets that were non-core or that did not fit their strategies.
As a result, today’s REITs are in relatively good shape, characterized by lower risk, better yields and better capitalization.
With ever larger funds being raised, more products and strategies being offered to investors and greater demands for transparency and improved reporting, fund managers are increasingly looking to outsource their administration.
Outsourcing to fund administrators can provide clear benefits, such as a more flexible use of resources, an ability to focus on revenue and return-generating activities, a more scalable platform, assurance for investors that reporting is being managed by an independent third party and more predictable operating costs.
For new firms, outsourcing can be a relatively easy decision. For established firms, however, the deciding factors are likely to be more nuanced.
Focus on Brazil, China and Israel
For investors that understand the Brazilian real estate market, now may be the best buying opportunity in at least a decade. Prices are low due to three factors: a significant currency correction, an economic slowdown and resultant oversupply of real estate and a decade of high construction levels that has exacerbated the oversupply.
Following the summer’s stock market correction and the renminbi’s devaluation, it’s clear that some investors have become more cautious about parts of the Chinese real estate market. With pockets of overdevelopment in some areas, investors need to choose their markets wisely in China.
Low interest rates and growing demand from investors for international exposure is making the Israeli bond market an attractive source of capital for real estate funds. While the flow of issuers has largely come from the US, there are signs that some companies in other regions, such as the UK, are eyeing the market with interest.
Although some are raising warning flags, we believe the outlook is positive, based on both macro and micro economic factors.
A stable inflationary policy continues to benefit asset prices, while lower unemployment and relatively low commodity prices also play a beneficial role. Also, the slow post-crisis recovery has allowed supply to match demand more closely than has historically been the case after a downturn.
Real estate funds continue to attract high levels of capital, with successful closes across the real estate investment spectrum, from value-added and opportunistic to core and distressed.
In the past, warning flags would be justified seven years into an economic cycle, but market data suggests this cycle will be longer than average.