Private real estate activity has slowed so far in 2020 as the pandemic impacts sector dynamics
Q1 2020 hedge fund letters, conferences and more
The private equity real estate (PERE) market is in an unexpected position. 2019 could be characterized as a banner year for the industry: assets under management (AUM) reached a peak at $992bn, private real estate funds raised a record $151bn, and PERE deals amounted to more than $400bn for the third consecutive year. But after outbreak of the novel coronavirus, the industry finds itself in a very different situation.
Sector Dynamics Are Evolving
Beyond the economic fallout from COVID-19, restrictions to daily life and travel are altering PERE markets globally. Investors and business sectors have had to modify their behavior and operations due to social distancing requirements, and certain PERE sectors are under particular strain.
Demand has fallen significantly for brick-and-mortar retail, hospitality property, and hotels, which are all now at risk of lower-than-expected financial performance as a result of significant restrictions on domestic and international travel. Rocco Cortese, Managing Director at California-based Intersection, believes that “hotels and retail are going to be hardest hit. The impact of CARES stimulus and Payroll Protection will help, but it will take time for the public to resume business as usual.”
Meanwhile, the logistics industry is under increased strain as consumers turn to online shopping – in particular for groceries – to fulfil their needs. Amid these developments, many fund managers are focused on navigating their property portfolios through this difficult environment, rather than looking for new opportunities.
Deal Flow Has Slowed Worldwide
As such, PERE deal-making activity slumped in Q1 2020. In the first quarter of the year, $76bn of PERE deals were completed, a significant decrease from $114bn in Q4 2019 and the 2019 quarterly average of $108bn. The total number of transactions declined in all major property markets in Q1 2020 vs. Q4 2019. The hotel sector was hit hardest: the 68 hotel PERE deals recorded in Q1 2020 represent roughly half (47%) the total in Q4 2019. The office market, traditionally the largest market for PERE investment and therefore a key driver behind global trends, also saw reduced activity: the number and total value of deals for office assets decreased by 37% and 24% respectively compared with the previous quarter.
In contrast, though, demand for multi-family assets is relatively stable as investors look for cyclically resilient assets in order to protect capital. The residential sector has witnessed a comparatively low decline in deal volume, dipping only 14% from Q4 2019 totals to $37bn in PERE deals completed in Q1 2020. This figure was boosted by a mega deal completed by Blackstone Group: the US-based real estate fund manager acquired a portfolio of Japanese rental apartments for $2.7bn in February 2020.
Overall, the deal-making slowdown was felt across all major regions. Compared to Q4 2019, the number of deals completed in Q1 2020 halved in each of Asia and Rest of World, and declined by about one-fifth in each of North America and Europe. The aggregate value of deals was lower in each region barring Asia, which was buoyed by the aforementioned Blackstone Group mega deal.
What Does the Future Hold?
COVID-19 will undeniably continue to impact the market in 2020, but private real estate remains a long-term investment. As fund managers hold property for several years, they will likely be able to navigate short-term challenges. Some fund managers, asset owners, and tenants may be able to mitigate near-term difficulties through government stimulus packages and the fiscal and monetary policies implemented in response to the crisis. And if we see a fundamental change in pricing when market and social dynamics settle, GPs will likely be able to capitalize on lower prices, distressed assets, and low financing costs. That said, GPs planning sales in 2020 or 2021 may now have to re-evaluate their exit strategy if prices or demand are low.
Although the long-term outlook for the PERE market is generally positive, the uncertainty and behavioral changes caused by the pandemic will have far-reaching implications. It’s possible that remote working will become more ingrained in company culture, leading to changing requirements in the office market. Peter Lewis, President of New York-based Wharton Equity, believes that “the office sector could be reshaped as employers come to realize that companies can function nicely with remote working environments, augmented by technologies like Zoom video-conferencing.” Ordering groceries online may also become habitual for consumers, which could increase demand for logistics assets in the food industry.
As we wait to see how changing consumer behavior will affect private real estate demand in the longer term, we expect investors and fund managers to continue to exercise caution.
This article is the first in a series analyzing the impact of COVID-19 on the private real estate market, produced in collaboration with our partner EisnerAmper. We will be discussing deals, fundraising, and other key trends in the industry.
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For more insights and analysis on the impact of the pandemic on alternative assets, take a look at our COVID-19 Knowledge Hub.
Article by Lisa Knee, National Leader – Real Estate Private Equity Group, EisnerAmper – Preqin
