News

It was an underwhelming year for the global real estate market. As high interest rates continued to dent capital values and fuel refinancing concerns, deal volume, fundraising and investment performance fell short in 2023. Only 2,918 deals closed over the first three quarters, with an aggregate value of $88.8 billion, according to Preqin’s 2024 Global Real Estate Report. This represents only 42% and 35%, respectively, of the total deals closed in 2022. Capital raised during this period totalled $107.7bn, representing only 56% of the total raised in the previous full year. According to McKinsey[1], real estate funds returned –4% in the first nine months of the year, losing money for the first time since the 2007–08 global financial crisis.

PERE’s Investor Perspectives 2024 Study found that while investors expect RE to continue to underperform in next 12 months, appetite remains healthy; 39% of investors surveyed intend to invest more capital in the asset class over the coming year.

However, strategy and sector preferences have shifted.

Strategies

With higher-for-longer interest rates continuing to put pressure on financing, investors have responded by shimmying along the risk-return spectrum. They are favoring capital growth over income return for direct property investments and turning to distress as an opportunity. In their shift toward Value-Add and Opportunistic strategies, investors have been seeking liquidity via redemptions in Core and Core-Plus open-ended funds, forcing a wave of ‘gating’ and winding-up of such structures. Net outflows from open-ended vehicles reached their highest level in at least two decades, according to McKinsey.

In Europe, Opportunistic funds saw a surge in demand in 2023, while Value-Add strategies closed the highest number of real estate funds since 2021.

Assuming interest rates come down in 2024 and beyond, Preqin expects Value-Add strategies to experience the strongest growth in assets under management followed by Opportunistic, and from 2023 to 2028, the strategies’ AUM are projected to grow by 7.9% and 7.4%, respectively.

As distress and special situation investment opportunities grow in appeal, investors are gravitating towards larger, more experienced managers – especially in these uncertain market conditions. The adverse effect on first-time managers is apparent – they raised just $2.8bn in 2023, a steep fall from the $15.2bn raised in 2022.

The denominator effect, brought on by slipping values of public holdings earlier in 2023, saw many institutional investors pause on new private market commitments. In particular, real estate debt funds took a hit – with the capital raised declining 56% year-on-year, according to Preqin – despite the higher yield environment.

Sectors

Many real estate investors are redirecting their focus to sectors where they have little exposure, or where they see ripe opportunities.

The office sector remains out of favour, and that is not expected to change anytime soon. With continued capital value declines and elevated vacancy rates, the sector has suffered three consecutive years of shrinking transaction volumes, according to Preqin. Investors continue to be favorable toward industrial properties, as well as hotels amid a revival in tourism and business travel post-Covid (appetite for hotels has more than doubled from 5% to 12%) and student accommodation (appetite doubled to 20%), at the expense of data centers and healthcare real estate, PERE found.

Meanwhile, the continuing need for residential supply has investors continuing to prioritize residential investment strategies.  According to PERE’s study, the sector is a top choice, with one third of investors planning to inject new capital. Multifamily is the preferred subsector (65% of investors), while appetite for build-to-rent grew 9% year-on-year.

On the 2024 horizon

In the face of persistent market headwinds – namely, reduced valuations, the higher-rate environment and financing issues, year-on-year real estate fundraising and AUM growth is expected to remain subdued in 2024. However, investment sentiment – particularly toward Opportunistic and Value-Added real estate – looks set to pick up. We also expect an enhanced focus on niche strategies such as climate and the green transition, infrastructure, and digital assets.

Meanwhile, direct and co-investments will continue to be a growing staple for LPs as they seek reduced fees and greater flexibility.

Where are the active LPs? Despite the slowdown in investment pace for corporate and public pensions and established endowments and foundations, there is an underlying set of new investors – family offices, newly emerging endowments and foundations, consultants taking on new clients, RIAs – that are not at their allocation and remain opportunistic. There are signs of growing optimism from LPs about returning to market and deploying capital; it is the highest conviction level from LPs about opportunities in real estate since 2013.

[1] https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/mckinseys-private-markets-annual-review