Institutional investment and private equity look to reenter the commercial real estate game after staying on the sidelines during COVID-19.
When the COVID-19 pandemic swept across the globe in the first quarter of 2020, few even attempted to predict what would happen in the next few days or weeks — forget about months or years. The black swan event that was always a possibility, however unlikely, became a reality that shocked commercial real estate. That initial trauma was significant enough for many active and potential investors to take their money and go home, at least for a period long enough to catch one's breath and see how things shook out.
But now, halfway through 2021, vaccination rates have continued to tick upward, economies are fully reopening, and commercial real estate professionals are standing on ground solid enough to look at a new marketplace that has potential. For private equity, that pent-up demand could mean a healthy appetite for investment after the aggregate value of private equity real estate transactions fell by nearly 50 percent in 2020, to $146 billion after topping $290 billion in 2019, according to Preqin.
“Remember where we were [in March 2020],” says Mark Cypert, CCIM, a partner with Middleton Partners, a Dallas-based private equity investment firm. “There was so much fear and uncertainty that created a huge pendulum swing away from investment. Now, with investors feeling better about the future, it's almost like we're reversing course just as rapidly.”
According to Preqin, private real estate investment funds have $356 billion in dry powder, which is $1 billion more than they at the beginning of 2020, a few months before the pandemic. As the fear of 2020 recedes, that sidelined capital will reenter commercial real estate, perhaps first as a trickle but eventually as a steady flow.
“Overall, I'm bullish about what's to come in the next six months,” says Josh Herrenkohl, senior managing director at FTI Consulting. “In many respects, some larger investment firms were expecting more distress than what we're seeing now, so the second half of 2021 and 2022 could see an acceleration in the market.
“The question is, what's going to be the point when investors jump in? My guess is that the larger institutional firms like Blackstone or Brookfield will have transactions first that will give license for many others to join in.”
To that end, in June, Blackstone announced a $6 billion deal for Home Partners of America, a firm that owns more than 17,000 single-family rental homes.
“This is one of the most active markets I can remember; both institutional and private equity is very robust right now,” Cypert says. “There is more money looking for deals than there are deals to be found, so it's red hot. There's a lot of money that's been raised now — people believe that we're poised for a nice economic recovery and a rebound.”
Roads to Recovery
As 2020 came to a close, signs of optimism started to appear on the horizon. The development of multiple vaccines was one bright spot, even if distribution was still up in the air. And political question marks surrounding the 2020 elections were settled in early in January with the Georgia senate runoffs.
As the national economic recovery gained momentum in the early months of 2021, excitement rose for recovery in market sectors that were severely impacted by the pandemic. While the real estate cycle is not directly tied to the national economic cycle, it can be a delayed mirror of it. The CRE market doesn't react immediately to changes in the U.S. economy, but it improves as broad economic growth ultimately increases demand for many real estate sectors.
Hospitality may have been the market most closely tied to the ups and downs of the pandemic. The immediate economic shutdown wrecked the hotel business, but a resumption of leisure travel in the first half of 2021 has led to a partial recovery. The resumption of business as usual, though, could open opportunities to find deals on distressed assets.
“Hospitality probably should have been a lot more damaged than what was the case,” Herrenkohl says. “But in many cases, I think lenders didn't want to foreclose on assets because they would have to take them off their books and be responsible for them. I think it's possible, as things improve and forbearance agreements come to a close, we may see more available assets in hospitality.”
While travel and leisure assets are required to react quickly to changing demand, the office sector is afforded a longer timeline in experiencing the overall impact of COVID-19.
“On the investor side of things, the general feeling is that we won't be back to 100 percent of office occupancy from before the pandemic,” Cypert says. “However, that's been offset with growth in the overall economy. And with those who are coming back to the office, you're seeing a demand for more space per employee, which is a change after years of decreasing square feet per person.”
The CRE market doesn’t react immediately to changes in the U.S. economy, but it improve as broad economic growth ultimately increases demand for many real estate sectors.
It's also important to remember how quickly perspectives can change in a situation as volatile as a global pandemic.
“If you look back to last August, CEOs of large corporate occupiers were planning to significantly shrink their portfolios,” Herrenkohl says. “That sentiment has subsided significantly, with in-person work becoming viable again and businesses resuming 'normal' activity.”
While the industrial sector has emerged as the indisputable star in the wake of COVID-19, retail is a sector that continues to see widely varied results. Grocers, home improvement stores, and other essential businesses saw strong and steady demand throughout the pandemic, while restaurants, boutique retail, and suburban mall spaces experienced unprecedented challenges.
“Over the last 12 to 16 months, we've seen two different tracks in retail,” Herrenkohl says. “Looking at Class B or C malls, they were on a downturn before the pandemic, so it just accelerated what was already happening. But it will be interesting to see how retail bounces back. Will these malls or parts of malls be turned into distribution centers? Repurposing these spaces could be an appealing investment opportunity to those looking for a bargain.”
There are plenty of reasons to be optimistic, but if 2020 taught us anything, it's that the future isn't guaranteed. Experts note potential difficulties that could hamper a robust recovery for CRE — including CCIM Institute Chief Economist K.C. Conway, CCIM, MAI, CRE, as noted in his midyear market update. Inflation, COVID-19 variants, and job vacancies could be problematic in 2H2021 and 2022. But private equity experts expect the good times to roll in the near future.
“We are all aware of lumber prices, energy prices, and food prices,” Herrenkohl says. “One common view is that this is a one-time correction, but if it continues, that will obviously impact long-term outlooks.”
Inflation, COVID-19 variants, and job vacancies could be problematic in 2H2021 and 2022. But private equity experts expect the good times to roll.
But inflation, while troublesome for the national economy, may not be as worrisome to CRE professionals.
“As it relates to real estate, historically, inflation has not been a huge detriment to hard asset prices,” Cypert says. “Inflation will not have a big impact, unless it reaches too high a point or leads to stagflation. I don't think private equity investors are too worried about its impact, though.”
While institutional investors represent some of the largest players in commercial real estate, the pandemic reminded everyone that national trends all rely on local markets. Capital can readily flow from major urban areas to suburban or secondary markets.
“Speaking in terms of the big picture, things look favorable,” Cypert says. “I expect private equity to continue to have a good run on commercial real estate for the foreseeable future.
“But it's important to remember this is all a function of local markets. You make money at the local level — understanding your specific properties and how they're positioned to perform relative to competitors. That has not change nor will it ever change. That's the most important aspect of commercial real estate.”