The real estate market is currently experiencing a phase of pricing discovery as interest rates continue to rise. This adjustment period will lead to a reduced pace of investment activity until inflation is under control and interest rates stabilize. In this blog, we will explore what can be expected during this market reset and provide insights for investors and industry professionals.
Market Inertia and Pricing Recalibration:
During the pricing recalibration phase, we anticipate lower levels of investment activity as valuations catch up with market realities. Bid-ask spreads are likely to shorten as consensus is reached on where pricing should be. It may take around six months for this process to unfold, and during this time, we can expect reduced transaction volumes. However, refinancing requirements will drive valuations, ultimately presenting opportunities for debt placement.
Cash Remains King:
Equity-driven investors, particularly private buyers, will continue to be active in the market despite the recalibration. These investors, who are less hindered by market forces, will seize the opportunity to bid for assets in an environment with limited competition from other buyers. Markets offering long-term stability and “trophy asset” status, such as London’s West End, are expected to remain particularly active. Additionally, companies in need of a cash injection or those seeking to upgrade existing assets in partnership with investors will present opportunities for strategic acquisitions.
Working the Capital Stack:
The annual requirement to refinance assets creates opportunities for the creation and deployment of debt funds, especially considering the higher returns generated by financial markets. As the reset progresses, we anticipate North America to be the first to adjust, followed by countries such as Australia, the UK, Singapore, South Korea, and continental Europe. The speed and depth of pricing adjustment will vary by location, influenced by local market composition, fundamentals, and liquidity.
Limited Loan Covenant Breaches:
Compared to the global financial crisis, loan-to-value (LTV) ratios in Europe are significantly lower, averaging at around 30%. This indicates that a substantial shift in yields, well over 200 basis points, would be required to pose significant problems in terms of loan covenant breaches.
Defensive Assets in Favor:
During the market reset, defensive assets such as industrial and logistics (I&L) properties and residential assets are expected to demonstrate rental stability and growth potential. Core office spaces also fall into this category. However, it’s crucial to remain cautious of incoming rental caps for residential properties in Europe. The demand for I&L properties, driven by low vacancy rates, digitization, and potential growth in e-commerce, is likely to support stable rents in the short term and a swift rebound in rental growth as economies respond.
Closed-End Fund Terminations and Contracyclical Investments:
As the reset progresses, we anticipate closed-end fund terminations, which will bring assets back to the market upon fund expiry. This development will inject additional activity and present opportunities for interested investors. Countercyclical investment strategies, particularly sale and leasebacks, are also expected to gain traction, as savvy investors seek to capitalize on market conditions.
While the real estate market undergoes a pricing reset, it’s important for investors and industry professionals to stay informed and adaptable. This period of adjustment may last between 6 to 24 months, with varying timelines across global markets. By recognizing the opportunities presented by cash-driven investors, working the capital stack effectively, and focusing on defensive assets, real estate professionals can navigate the reset and position themselves for future success.