The private real estate industry is at something of a crossroads as we start 2019. An extended period of strong performance has left investors largely satisfied with the asset class; however, there are undoubtedly significant challenges ahead that will need to be navigated for the asset class to continue to grow.
The Star Performer
Performance of private real estate investments has been impressive over the one-, three-, five- and 10-year time periods, and has typically outperformed most public markets and other private capital strategies. This has resulted in general satisfaction among investors with their real estate portfolios: over a quarter (26%) of surveyed investors said their real estate investments had exceeded expectations over the past year, while a further 64% had their expectations met. Furthermore, capital distributions back to investors have been strong, with 2017 (the latest full-year data available) marking the fifth consecutive year in which investors have experienced positive net cash flows.
Consequently, investor appetite is strong, with a far greater proportion of investors looking to increase (36%) their allocations to real estate over the longer term than decrease them (10%), meaning that the strong fundraising environment of recent years is likely to continue. Although the amount of capital raised by funds closed in 2018 ($124bn) was lower than the record seen in 2017 ($132bn), 2018 marked the sixth consecutive year in which more than $100bn was raised by real estate funds closed.
As at June 2018, total AUM exceeded $900bn for the first time; while this is undoubtedly positive news for the industry, this growth also presents increasing challenges for industry participants.
Challenges to Navigate
Competition is as intense as ever: more than half (55%) of fund managers have witnessed increased competition for portfolio companies, and there are more funds than ever before in the market competing for investor capital – 670 funds are seeking an aggregate $244bn. Fund managers are therefore having to work harder than ever to secure capital, put it to work and deliver to investors.
After several years of expansion, valuations are largely considered by both fund managers and investors to be high: 60% of surveyed fund managers had witnessed an increase in prices over the course of 2018, and 54% of investors feel asset valuations are too high. Such an environment is undoubtedly harmful for return generation. A significant 64% of fund managers with vehicles currently in market have lowered their targeted returns as a result of high valuations, and a third of investors believe their real estate investments will perform worse in 2019 than in 2018.
There are also concerns that distributions to investors are slowing: the $212bn distributed to investors in 2017 was lower than the $270bn in 2016, and with $47bn called up in the first half of 2018 vs. $49bn distributed, there are concerns net cash flows could slip into negative territory. In addition, the number of private equity real estate deals significantly outpaced exits during 2018, which will also feed through to reduced cash flows in the near future.
This may, then, impact the amount of capital investors commit during 2019. Although the long-term outlook is positive, over the next 12 months, similar proportions of investors are planning to increase (23%) their allocations as those planning to decrease (19%) them.
Opportunities Still Exist
The real estate industry clearly faces challenges ahead, which is to be expected following an extended period of strong returns and with the prospect of rising interest rates. That said, opportunities still exist, albeit perhaps are harder to identify, and fund managers and investors alike will have to work hard to select the most appropriate strategies, geographies and partners to ensure real estate continues to deliver.
For expert commentary, key trends, historical statistics and survey results, take a look at the newly-released 2019 Preqin Global Real Estate Report – the most complete and in-depth review of the industry available.