Real Estate Private Equity in 2022

by Alice Estellat, Apolline de Vulpillières, and Inès Mazzola

Introduction

Despite record investment and exit activity in 2021, there was a significant slowdown in Private Equity (PE) activity over the past year. Macroeconomic factors, namely high inflation and rising interest rates, are certainly to blame. Yet, in an inflationary environment, investors tend to favour real estate as it can serve as a hedge against inflation and is thus a defensive long-term investment. This paper seeks to look at the performance of Real Estate Private Equity (REPE) in 2022 and explore how the sector has been impacted by the current geopolitical and economic turmoil.

Fundraising

Through 2022, real estate activity had been negatively affected by increasing interest rates, volatile asset valuations and concerns about housing market corrections. Indeed, investors are becoming increasingly risk averse and holding off on making commitments to real estate investment vehicles until there is more visibility on how the industry navigates the economic turbulence. According to Private Equity Real Estate (PERE), REPE markets fundraising for the year to the end of Q3 came in at just over $107bn, the lowest total for the first nine months of a year since 2013. Global REPE fundraising slumped, as of December, aggregate REPE fundraising for the year stood at $160.6bn, 24% lower than the capital raised for all of 2021. The number of funds closed dipped 41.3%, from 588 vehicles the previous year to 345. In the fourth quarter, global REPE funds raised $43.23bn, down 46.7% from $81.14bn raised during the fourth quarter of 2021.

Market Trends Shaping Real Estate Investment

Inflation has put increased pressure on consumers, making renting more affordable than buying. This explains why real estate is said to hedge inflation; landlords can increase their rents in case of inflation which increases the cash flows for property owners. If we add rising interest rates, mortgage rates increase as well and this makes it more expensive for all. With rising interest rates, demand for rental homes increases as well, as it becomes more expensive for potential buyers to finance purchases that create upward pressure on rental prices. Mortgage interest rates have risen along with inflation, with the rate on a 30-year fixed mortgage reaching about 7%, usually at 3%. Moreover, the energy price shock has drastically increased production costs.

Longer to Close Real Estate Transactions

For commercial property owners, patience is the new gold. The trend shows that cross key European markets, real estate transactions are taking longer than ever before. Overall, the duration of a real estate deal from the bidding process to the closing has drastically lengthened over the last 3 years. While in 2019, the number of days between the start and close of transaction was just 165, in the first half of 2022, this figure had shot up to 258, a 55% increase in the average duration.

The Sub-sectors of Real Estate

According to real estate professionals, the logistics and residential asset classes are the most attractive with a respective share of 34% and 27%. For investors, they offer the greatest investment opportunities, due to their stable cash flow and manageable risks. Professional spaces (16%) remain attractive, even if many employees work more from home. The pandemic impact is still present on office and retail, which were high growing sub-sectors before covid disruption.

Multifamily Real Estate:

Although the existing property segment has seen a 5% year-on-year decline in volume, it nevertheless remained at historically high levels in 2022 with more than 1.1 million transactions completed in the course of the year. Prices, which continued to display strong annual growth of 6.4% in Q3-2022, testify to the overall buoyancy of this segment but still reflect an imbalance between stagnating prices in major metropolitan areas versus a faster pace of price increases in other regions, with an 8.1% rise in the provinces. The trend towards urbanisation and a preference for rental housing over ownership continued to drive demand for apartments. With the pandemic, the war in Ukraine and inflation, 2022 saw a dramatic rise in property prices. Indeed, between March 2020 and October 2022, the value of a typical US home increased by over 41%. By way of comparison, the annual increase in house prices has averaged 4.4% since 1991. Obviously, this major increase has affected home buyer demand by exacerbating affordability problems and at the same time this has created opportunities for investors who have access to off-market properties (which sell for less) and different financing options.

Data Centers:

The growth of cloud computing and the increasing amount of data being generated and stored fueled demand for data centres. The efficiency and high-value of data centres assets attracted a lot of investors seeking benefit out of it. Furthermore the strong growth of cloud services and outsourcing trends are fueling a drive to increase the outstretch of data centre operators.

According to IT research firm Gartner, the projected worldwide spending on data centres will grow to $226bn in 2022, up 11.4 percent from 2021.

Retail:

Retail was expected to recover from the pandemic but this year’s instability has postponed its performance. Transaction volume in the third quarter of 2022 for office space was down 33% versus the third quarter of 2021, driven by a lag in return to offices and the associated increase in subleases, combined with record lease expirations. The retail sector was counting on 2022 as the year to recover from the hard blows delivered by the pandemic and lockdowns. However, as the invasion of Ukraine and rising inflation have come on top of the existing pandemic-induced turmoil, we expect that the retail investment market will keep realigning and repricing itself until 2023.

Office:

The new trend of working from home allows for movement from primary to secondary homes. Such a new paradigm increased the demand for secondary homes. Despite a creeping return to the office, hybrid work remained a non-negotiable component of the new “social contract” that employees seek. Therefore, while the pandemic caused a decline in demand for traditional office space, demand for flexible and collaborative workspaces increased.

Logistics and Industrial: With the rise of e-commerce, the demand for warehouses and distribution centres increased. It has been one of the favoured asset classes for real estate investors, reinforced by the pandemic as e-commerce and supply chain issues accelerated occupier demand. Available supply has declined in the last three years. Economic and geopolitical environment will maintain low space availability as new developments are constrained by land shortages, rising construction costs and inflationary uncertainties in financing projects.

Hospitality:

Hospitality decreased by 21% for the third quarter of 2022 as compared to 2021. However, the post-pandemic recovery is continuing, particularly given the demand from leisure travellers willing to spend on experiential hospitality, as well as the status of the sub-sector as a high-conviction theme in the portfolio of many asset managers.

Health Care:

The aging of the population and advances in medical technology created demand for medical office buildings and senior housing.

Outlook for 2023

In the face of uncertainty on many fronts, the robustness of the market leads people to think that commercial real estate deal activity in 2023 will continue to display its proven resiliency.

In 2023, there is an opportunity for investors in office space to get close to the customer, which presents a more compelling work opportunity. The retail sector was counting on 2022 as the year to recover from the hard blows delivered by the pandemic; it is only a postponed recovery as it is expected that the retail investment market will keep realigning and repricing itself until 2023.

Moreover, the real estate and construction sector, currently responsible for almost 40% of final energy use and process-related CO2 emission, has a critically important role to play in meeting international goals under the Paris Agreement. In fact, the World Green Building Council has set major goals to ensure that every building achieves net zero emissions by 2050. This requires the integration of various energy-saving technologies and sustainable building practices. Therefore, we can see that the increasing awareness and concern about the environment are shaping the real estate industry in several ways. For example, the demand for green and environmentally friendly buildings is growing, which has led to an increase in the construction of energy-efficient and sustainable buildings. This trend has prompted real estate developers to focus on environmentally friendly features, such as renewable energy sources, water conservation systems, and materials made from recycled content.

Conclusion

After a great promise post-pandemic, the end of abundance is a tough time for the industry. But the sector still displays large opportunities. Property markets may not provide as much shelter from inflation as investors might like, but they have at least become less likely to amplify financial trouble. Despite a fall from year-to-year due to difficult times, international real estate investment is on the rise. The market offers opportunities to increase the return on existing investments and the potential for diversification.