Both debt and equity will be required to refinance distressed debt and assets in this chaotic environment. New debt has become available from life companies, CMBS lenders and money-center banks. Significant equity is sitting on the sidelines waiting for the “right” opportunity. However, given the necessary reset of loan-to-value ratios, as bloated property valuations are adjusted to market, one has to wonder if there will be enough equity capital to fill the hole left by the collective deleveraging. As institutional investor appetite for private real estate equity continues to wane, alternative capital sources, including high-net-worth individuals and family offices, may be necessary to fill the void.
As we begin the second quarter of 2012, the economy is showing signs of life. The United States added, on average, 245,000 jobs in the three months ending February 2012. The national unemployment rate for January fell to 8.3 percent of the seasonally adjusted labor force. Of course, the European sovereign debt crises, the continued impact of high oil prices and the constant threat of geopolitical instability in the Middle East remind us of the fragility inherent in the current recovery. But uncertainty sometimes represents opportunity.
The improving CMBS market may help fill demand created by the refinancing and restructuring of distressed assets and the looming maturity of almost $1.4 trillion in commercial real estate loans from 2012-2015. However, additional sources of debt will be necessary, and an impending lack of equity commitments from institutional investors might leave a void on the other side of the capital stack, as well.
The public REIT market’s equity fundraising continues to increase, with REITs raising $35.2 billion in secondary equity in 2011, up from $26.2 billion in 2010 and $21.2 billion in 2009, according to NAREIT. Capital is also prevalent on the private side, but only for some. According to Preqin, fund managers had roughly $156 billion in dry powder as of year-end 2011. They had a similar amount of capital at their disposal, $172 billion, in 2007, but a more striking difference can be seen in the number of funds raised in each of those years: 344 in 2007 and 119 in 2011. Furthermore, more than half of the dry powder currently available, $83.2 billion, is held by funds focused on North American real estate. There is $36 billion held by Europe-focused funds and $32 billion by funds primarily focused on Asia and the rest of the world.
As illustrated in the chart, there was almost $49 billion in aggregate capital raised by private equity firms for commercial real estate last year worldwide, a modest increase from 2010. This suggests that the private real estate sector has yet to recover from the impact of the financial crisis and that fund managers are still operating in a challenging fundraising environment. Meanwhile, managers seeking to raise private equity capital are having trouble securing new commitments from traditional institutional targets, including pension funds, endowments, insurance companies and money-center banks. These institutions are understandably cautious, given the level of uncertainty prevalent in the market, and are staying on the sidelines, seeking opportunities with lower risk or demanding higher returns commensurate with the risk.
In fact, in January 2012 investor appetite was lower than it was at the same time in 2011 or 2010, according to a Preqin survey of more than 180 investors in closed-end private real estate funds. And only 36 percent of the investors stated that they were likely to commit to funds in the next 12 months, down from 45 percent about a year ago and 47 percent in January 2010. Even more telling, 53 percent of the respondents to the same survey indicated that they were unlikely to commit to private real estate investments in 2012, up from 49 percent in January 2011 and 38 percent in January 2010. Among those investors committing to private funds in 2012, 47 percent of the respondents intended to invest in core and value-added strategies.
High-net-worth individuals and family offices may fill this void. These investors would welcome the opportunity to access the private real estate equity markets and the higher potential yields such investments offer. Managers may need to string together hundreds, if not thousands, of these investors to amass the same amount of capital a handful of institutional investors could offer, but they could provide a much-needed lifeline now and a source for backing even when institutional investors return in greater numbers.
Steven Bandolik is a director and Michael Isroff is a senior manager for Deloitte Financial Advisory Services L.L.P. This article contains general information only and is based on the experiences and research of the authors. Deloitte Financial Advisory Services and Deloitte & Touche are not, by means of this article, rendering professional advice or services.