Having weathered a turbulent 2023, where capitalizing even the most seemingly straightforward transaction has felt like a herculean task, sponsors have been seeking guidance around how to get more deals funded in 2024. At the IMN’s 2024 Winter Forum on Real Estate Opportunity & Private Investing Conference, fund managers shared their viewpoints around how the current economic landscape will inform the availability of institutional capital, and the types of opportunities these investors are most actively pursuing.
It became clear early-on from the conversation, that for most panelists the equity investing environment is rife with risk that makes it difficult to fund with conviction. Canyon Partners’ Robin Potts explained. “We’ve been fortunate over the last year to have a debt and equity business because the equity business in 2023 was dramatically down as a result of things not penciling with negative leverage, so broadly, the headline being down 60% transaction-wise, the institutional world capital couldn’t move forward. A lot of what you saw get done was private capital.”
When asked if the prospect of underwriting lower interest rates in 2024 would prompt fund managers to close more deals, Potts was dubious. “If we are lender, we are utilizing the forward curve to make sure the deal pencils. On the equity side, it’s a bigger picture issue, so the rate environment feeds into how you’re valuing the asset at exit, how are you determining whether you’re going in cap rate makes sense. All of the variables need to be refined to a much bigger degree when you are last dollar equity exposure versus on debt where you have some cushion on a variety of assumptions. On the equity side, we are quite cautious in this rate environment and not looking to take on negative leverage.”
One bright spot for borrowers seeking capital was C-PACE (Clean Property Assessed Clean Energy) funding. Nuveen Green Capital’s Cory Jubran explained that the once largely unknown and misunderstood debt program providing funding for energy efficiency improvements on both ground-up and value-add developments had become a vital source of gap funding. “Our volume was up a lot last year. It was one of the best years we’ve had both for our group and C-PACE nationally. We fund 60-70% of all C-Pace paper across the country. As there become more difficulties raising equity or getting debt for particular deals, people are now realizing this C-PACE stuff may actually be accretive. So, our deal volume is up not necessarily because the broader markets has more deals, but because the percentage of deals that are going C-PACE has gone up. And this year we are anticipating the same.” He went on to explain a typical scenario where his capital was most accretive. “If you have a 75% LTV loan or 80% LTV loan at takeout and you only bought the project a year or two ago, you are probably having trouble. Banks and lenders are starting to scale back “pretending and extending” and as that becomes more difficult, people are looking to C-PACE to re-capitalize that position because it is cheaper than bank financing today and the paper is lot more borrower friendly. We see that a lot in hotels. Hotels are a large portion of our current volume, but now a decent amount is multifamily as well.”
According to Jubran, Nuveen’s ability to deploy substantial capital has been fueled by demand from large life insurance companies and pension funds. “They view 7.5-8.0% over the course of 20-30 years a great opportunity for them. We closed for last year’s strategy a $525 million fund which we’ve fully deployed already and we’re onto fund two, probably going to raise about $850 million, hopefully over the next couple of months. They like long-term, fixed-rate income producing types of returns, as well as we check the ESG box, which is very important, especially to European investors.”
But in other areas pockets of the industry, the fundraising environment has been far more tepid, meaning less money is coming into the industry than in more sanguine times. “In general, return expectations have gone up. 2023 was an extremely slow fundraising year, the lowest since 2012. Final closings for close-ended funds were down almost 70%. Investors were dealing with, the first half of last year, the denominator effect, uncertainty about the real estate book in their portfolios and how it was actually valued and marked, so they were uncertain about their actual real estate exposure. Investors were figuring out what problems they had in their portfolios. So, it was actually a very risk-off year for investors last year and they were most focused primarily on re-upping with incumbents if they did have the budget, but also re-upping in smaller dollar amounts. Looking to 2024, this should be a better year for investor allocations, budgets get set at the beginning of the year, the dominator effect is largely not in the conversation anymore, which is helpful. But something that investors did is make a lot of commitments over the last couple of years that have not been drawn down, so there is a lot of uncalled capital. They want to see managers actually deploy that capital before adding on.”
Justin Rimel, Senior Director at Invesco, argued that the sharp decline in transaction volume and a challenging fundraising environment had accelerated the need for fund managers to create differentiated offerings to attract future capital. For Invesco, that involves building virtually integrated platforms that don’t rely upon sourcing and external partnerships with GPs. “I would say deal flow for us is probably down 80% and on the equity side, even more. Strategically, more and more we are pivoting in business to do more verticalization efforts in specialty sectors. As we look towards lower fees, a more competitive environment, I think there will be more fallout in terms of performance and a narrowing of who the winners are and the losers in terms of who can attract capital. I think the best evidence of the classic allocator model is the amount of capital is being raised by specialty vertical integrated funds. I think industrial managers that self-execute and raise capital around that. Ten years ago, 30% of the capital was raised by groups like that. Today it’s probably 70% compared to a commingled fund. The LPs see performance, and double fees. The groups we’ve built up and others have built up over the years sort of changed the calculus a bit.”
One of the more interesting dynamics at play in the panel was observing the difficulties fund managers face responding to fears around softening market conditions and concentration risks on popular property types, while struggling to identify opportunities with better risk-adjusted return hurdles. Potts listed issues that continue to repeat themselves in many multifamily markets. “Concessions aren’t burning off, rent growth is not what is once was. We’re also seeing pressure on the operating side with insurance increases being pretty dramatic. With all of that compression on NOI margins, it’s certainly having an effect.” But even so, a clear alternative to multifamily and industrial had not emerged, according to Rimel. “We’ve been having a hard time casting a stone at why industrial and multifamily don’t take up most of the air space (in the investment community). That feels like what’s generally a consensus view, but it is a little scary. Like what could go wrong? We’re having a hard time finding a real alternative. When we look back and see the highest correlations of cap rate movement to capital flows a lot of times, that feels like a decent bet. But my view is that performance for multifamily and industrial may be pretty different this year, particularly those multifamily markets that are exposed to significant amounts of deliveries.”
Morgan Stanley’s David Pringle said his firm’s strategic investments in alternative segments like senior housing helped partially mitigate that concern. “Within that sector (senior housing) we’ve been able to see real revenue growth on a top line and bottom-line basis over the last year. And there’s also that nothing has been delivered through the Covid period. Construction has been delayed or reduced across a lot of sectors over the last year but in senior housing it goes back to 2020. That’s one area where we’ve been constructive. Medical office as well.”
Despite short-term headwinds, the panelists seemed confident that multifamily would remain a major focus for them. “The last twelve months have put a huge dip on the supply pipeline,” explained Potts. “There’s not going to be a huge pickup (in construction) this year. It’s still very hard to get new construction deals capitalized. When you look out over the next two years and the supply wave moves beyond us, it paves the wave for rent growth again. Fundamentally, multifamily is in a really strong position. When you look at demographics and how un-affordable home ownership has become. Home prices are still over 30% where they were in 2020. Interest rates as high as they are. Home ownership is 50% more expensive than renting. All of those are positive underpinnings for why we like multifamily, but again this year is going to be a bit bumpy.”
Overall, it seemed that regardless of asset class, fund managers are extending the same cautious disposition they did in 2023, while waiting for more transparency from the Fed. Pott’ summary of Canyon’s current orientation perfectly encapsulates much of the current fund universe. “We’ve been very active in our debt strategy and that will thematically be a more attractive area for us in 2024. But all eyes this year will be on the rate environment and if the Fed is right that it’s three cuts this year or the market’s right that it’s six cuts this year and that will have a big impact on whether transaction volume will pick up.”