Real Assets Archives

Now that we’ve set the scene for the current deal environment and fundraising conditions that real estate asset managers are encountering, we turn our attention to another real estate trend shaping these fund managers’ challenges and opportunities: the specter of refinancing

With the outlook for real estate deal activity and fundraising improving, the biggest financial challenge facing real estate investors in the coming quarters will be refinancing.

Billions of dollars of real estate debt – issued at bargain-basement rates at the peak of the credit cycle in 2021 – will mature in the next 12–36 months and must be refinanced at much higher costs.

According to Morgan Stanley analysts more than US$1.5 trillion of commercial real estate debt falls due for repayment before 2025. The delta between office and retail property valuations at the top and bottom of the market could be as wide at 40 percent, according to Morgan Stanley, resulting in heightened risk of default across the sector.

In this article, we explore the challenges real estate asset managers face as a result and the resources they can seek out to help mitigate the impacts.

The road from low rates to daunting refinancing

As interest rates hit new lows in 2021 in reaction to a Covid-rattled economy, real estate managers saw their investment target options open up.

Alongside the boon for real estate, private debt strategies experienced a rush from managers and investors eager to take part in the attractive terms. Real estate debt wasn’t left out of that equation. Managers with pure real estate strategies hurried to stand up debt strategy arms to meet soaring investor demand while those already raising real estate debt funds basked in the rush on their fundraising efforts.

Now, three years down the line, real estate managers and real estate debt managers alike are staring down the maturities of their loans.

Banks and capital markets are not completely shut, and there will be liquidity available to refinancing these debt maturities, but with interest rates settling at elevated levels relative to the last five years, interest rate coverage ratios could be a factor in determining whether senior loan and bond lenders will be able to fully refinance maturing debt facilities.

This could open up opportunities for junior capital providers to gain traction in capital structures, with mezzanine and preferred equity as some of the solutions that real estate companies could turn to when topping up capital structures.

As in the fundraising space, the upcoming refinancing wall could also lead to a split in the market between haves and have nots. Real estate borrowers in resilient sub-sectors that exercised restraint at the peak of the credit cycle should find refinancing relatively straightforward.

As one example of a resilient subsector, also mentioned in our previous article, the data center real estate market continues to perform, especially as we increasingly integrate AI and machine learning features into our daily lives and create a greater need for physical computing space to power that demand.

Borrowers that took on leverage too aggressively and are in weaker performing real estate sub-sectors will find it much more difficult and could encounter financial stress and distress. For example, many employers are still allowing for hybrid or fully remote work post-pandemic, and the office building sub-sector is still under close watch by the industry for fear of a crisis when these loans come due. Rebound rates can vary vastly city by city.

Arm your firm with resources and industry expertise

In a long game like real estate investing, we all know there will be times of feast and times of famine. Real estate managers can’t control the macroeconomic factors – only the way in which they run their funds, select their investments, create value, and manage risk.

When facing headwinds like the impending wall of real estate debt maturities we find ourselves with now, it’s essential to focus on the operational elements that are under a firm’s control. In getting back-office operations in order, funds can free up their teams to focus on value-added activities rather than getting bogged down in the administrative and technical challenges that come with managing a complex portfolio of properties.

Alter Domus has guided real estate managers through multiple cycles of the market over the last two decades. We’re prepared to help you operate through this challenging credit market with your choice of service model – outsourcing, co-sourcing, and lift-outs – as well as full back-office services including fund accounting, loan servicing, transfer agency, and far more.

Ready to empower your staff to outsource challenging workflows so they can work on higher-value problems and processes? Reach out to our team to start a conversation.

The real estate sector has endured a volatile 24 months, with real estate operators and investors not only having to manage the impact of higher interest rates on the sector, but also the long-term changes to real estate usage sweeping across the industry following the pandemic.

In the face of these multiple headwinds, global private market deal activity fell 47 percent in 2023, with real estate fundraising falling by almost a third year-on-year.

As the industry emerges from this period of dislocation, however, the outlook is improving. Interest rate stability will help to bring mainstream buyers and sellers back to market after a year of pausing for breath; while investors with the conviction to pursue deals in a still unpredictable market could be rewarded with bargain valuations.

Interest rates remain elevated from recent levels, but amidst uncertainty, real estate opportunities are emerging for savvy real estate players.

In this article, we’ll explore how three key facets will shape these opportunities in the months ahead and drive real estate fundraising and transaction activity.

Deal volume rebound in the right sectors

Real estate dealmakers stayed cautious and deal volume remained low as we moved into 2024. However, interest rate stability (even in a scenario where anticipated rate cuts are delayed) can help to support a recovery in certain real estate deal markets under the right conditions, such as residential real estate and industrial real estate. As vendors and buyers align on valuations and form a clearer picture on how to price risk and build deal structures, we hope and expect to see the same effects roll out to the broader real estate space alongside these stabilizing interest rates.

While Q1 2024 still saw a 6 percent year-over-year decline in deal volume, as JLL reported, “the pace of declines continued to moderate across the Americas and EMEA, an early signal of growth.” We’ve seen a cluster of high-profile real estate deals progressing this year to support this outlook.

In one of the largest real estate transactions since the pandemic, Abu Dhabi investment fund Lunate and Saudi Arabian firm Olayan Financing Company acquired a 49 percent stake in ICD Brookfield Place, the iconic Dubai office tower. Deal value was undisclosed, but Bloomberg reports that the property has been valued at an estimated US$1.5 billion.

Other notable deals in 2024 include Blackstone selling the Arizona Biltmore Hotel to UK-based real estate manager Henderson Park in a deal reported to be worth US$705 million, and investment manager Ares and landlord RXR forming a joint venture to invest in New York office buildings.

Real estate dealmakers will be cautiously optimistic that an improvement in Q1 2024 real estate transaction activity will carry through into the rest of the year.

Fit for fundraising

As real estate markets reopen, managers will hopefully be in a better position to realize portfolio assets and increase distributions to investors.

Increasing distributions will in turn put investors in a better position from a cashflow perspective, and more able to recycle distributions into the next vintage of real estate funds.

Fundraising, however, is likely to continue tracking trends observed in 2023, where the market bifurcated in favor of large real estate platforms or managers running specialized and distinctive strategies.

Through the headwinds that faced the market in 2023, investors moved to consolidate manager relationships and coalesced around large platforms, enabling large cap real estate managers to continue closing jumbo funds despite the large drop in overall fundraising. According to McKinsey, five managers accounting for well over a third (37 percent) of closed-end real estate fundraising in 2023.

Large managers are set to continue dominating fundraising, but investors are also looking for exposure to specialist strategies, with analysis from PERE showing that a higher proportion of sector-specific funds are closing or exceeding target sizes than generalist funds.

Shifting usage patterns

Looking at the challenges facing real estate from an operational perspective, the sector is still grappling with how to adjust to the shifting usage patterns that have reshaped real estate following COVID-19 lockdowns.

Home working habits have become entrenched following the lockdowns, putting severe pressure on office space valuations, while the ongoing shift to online shopping has had severe impacts on retail space.

Inflationary pressures, cost of living and supply chain disruption, meanwhile, have made for a choppy logistics market, where demand has slowed and higher vacancy rates have been reported, according to JLL.

But while some real estate sub-sectors have suffered severe dislocation, others are thriving.

The data center market is red hot, with CBRE forecasts showing demand rising to record highs in 2024 as vacancies fall to all-time lows, supporting robust rental rates. Strong demand from large cloud computing service providers serving the market with computing power and data storage at enterprise has shown no sign of slowing down and bodes full for sustained growth in the data center space.

Other strong performing areas include purpose-built student accommodation, where investors have seen strong operating performance and demand after lockdown restrictions eased and campuses reopened, with demand for life sciences lab space also high, underpinned by advancements in diagnostics, personalized medicine and genetics.

Shifting usage patterns, however, will also provide opportunities for contrarian investors who have the conviction to lean into sub-sectors deemed “unfashionable” and back assets at attractive valuations.

Contrarian investment opportunities could include retail and shopping center assets that have survived the last decade and proven their resilience, or Chinese real estate, which has gone through a severe liquidity squeeze but may now be coming out the other side.

Overall, market dislocation has increased real estate investment risk, but also opened opportunity.

Take on real estate industry challenges with Alter Domus

The real estate sector has encountered considerable challenges in the past few years but signs of promise continue to emerge. To make the most of the emerging opportunities and push through the trials, having a trusted partner on your side is essential.

At Alter Domus, we have decades of experience in weathering the ups and downs of the real estate market and providing essential fund services through challenging times, from fund administration and property accounting, to AIFM services and depositary offerings, and more.

Reach out to our real estate services team to learn more about how we can help.