Capital Considerations
Recapitalization is driving much of the movement in real estate today. The availability and cost of capital has been a major consideration in how real estate markets function in the United States and Europe over the past three years. Equity and debt capital availability has shifted due to regulatory, portfolio management, liquidity, investor redemption, and other considerations. The result is a profound opportunity for investors across debt and equity.
In the United States, banks account for some 50% of commercial real estate lending and have pulled back dramatically on lending due to regulatory pressure and challenges with existing real estate loans, particularly in the office sector. While insurance companies and non-bank lenders have been more active, they are not large enough to make up for the gap in real estate funding.
Lenders have been able to earn double-digit returns and double-digit yields in the junior tranches of first mortgage risk. Non-traditional lenders such as hedge funds and other private capital have entered the market as a result, and since the beginning of the year, we have seen real estate credit spreads tighten. However, we still see attractive absolute returns available in real estate credit overall.
Transactions, Transactions, Transactions
The real estate equity markets in both Europe and the United States are at a critical turning point. With many equity owners under growing pressure to sell assets, we are seeing more opportunities to buy high-quality assets in sectors with strong fundamentals at attractive valuations. While a significant gap between what sellers were willing to accept and buyers willing to pay for property kept transaction volumes muted for the last two years, we are seeing that gap narrow as sellers become more realistic and motivated to sell at the same time as financing markets are allowing buyers to improve their bids.
Our own pipeline reflects the shift: In the first six months of 2024, we have closed on or contracted $12 billion in real estate transactions all over the world. In the United States and Europe, we are seeing recapitalization needs leading directly to transactions, including with REITs selling assets to gain liquidity and open-ended funds managing redemption and liquidity needs by selling property. In Japan, shareholder activism is pushing publicly traded companies to identify ways to increase returns, leading to many corporate behemoths selling off large real estate holdings that are not core to their business. The common thread: transactions borne of pressure on owners to free up capital for other uses. Investors with multiple, flexible pools of scaled capital are likely best positioned to take advantage of the opportunities we are seeing today, which occur around the globe and throughout the capital stack.
Conclusion
Both our quantitative research and our experience suggests that investors who take concentrated risk in a specific market, theme, or even invest too heavily during a particular period of time may not be maximizing their long-term risk-adjusted return potential. If the past few years have taught us anything, it is that concentrating in an asset class or with direct exposure to a set of individual assets can leave investors vulnerable to unforeseen challenges related to macro conditions, fundamentals, or liquidity. In our view, going global, investing in both equity and credit, concentrating on themes with solid long-term fundamentals, and maintaining a disciplined approach to investment over time is a better way to look for value in the asset class than taking highly concentrated bets.
