Although the private equity and real estate (PERE) markets have been volatile for the last few years, investors are still actively making deals. According to Business Insider, residential investors are poised to save the residential real estate market. Meanwhile, commercial real estate investors are sitting on the sidelines, waiting to jump on opportunities.
There’s just one thing that could complicate your PERE plans: a scarcity of real estate credit.
Even in the alternative lending market, there are only so many lenders available for every borrower. For some general partners (GPs) and limited partners (LPs), it’s a great time to invest in real estate credit. For others, however, it’s a better time to capture liquidity, capitalize on new opportunities, and wait out the high interest rate.
This shortage of real estate credit means that PERE dealmakers trying to fund deals may find themselves jumping through more hoops and vetting more lenders than before. Learn how the current market is affecting PERE dealmakers and how your firm can best support them.
Lenders are struggling with the real estate credit roller coaster
Real estate credit has been highly volatile in the last few years. In 2021, many real estate investors were focused on exploring post-pandemic opportunities. Now, the cost of capital is on the rise — and both commercial lenders and alternative lenders are pulling back.
According to Lauren Hochfelder, Managing Director of Morgan Stanley Real Estate Investing: “The degree of dislocation or pullback in the debt markets was underestimated going into year-end. Many markets remained optimistic that banks would be ‘back’ come January 1. It sounded a lot like the 2021 refrain that everyone would be back in the office come Labor Day.”
Investors initially expected alternative lenders to pick up the slack in the debt markets, but many alternative lenders still need to borrow money from commercial banks — and commercial banks are stalling lending across the board.
Consequently, some investors are focusing on smaller, unleveraged deals. Other investors are shying away from areas and asset classes where liquidity could be low, such as construction or development projects. Meanwhile, PERE dealmakers continue to reach out to credit unions and banks to build their inventory of lenders.
Alternative lenders are trying to fill the gap — but they’re overwhelmed
Previously, alternative lenders were willing to fund smaller, subprime deals. Now, traditional banks around the globe are pulling back, and alternative lending is on the rise for investment management and investment property firms. Many alternative lenders are seeking to build diversification through real estate credit investments — but it may not be enough to maintain cash flow within the PERE market.
Natalie Howard, Head of Real Estate Debt at Schroders, states: “There are just 8 to 10 alternative providers operating in the European lending market today, which is not many for a €1 trillion market. Around €200 billion needs to be refinanced every year, so it’s a very big space with not enough lenders to fill it.”
Simply put: There aren’t enough alternative lenders in the market, and the commercial bank squeeze is only further hurting their ability to act. The complexity of real estate also poses a challenge to alternative lenders. Lenders must have specific knowledge within the real estate market to adequately rate risk for various property types and real estate assets. Not every alternative lender has a professional on staff who is highly skilled in underwriting real estate loans, even if they’re well-versed in other aspects of the credit market. Still, Howard notes that real estate credit is exciting for LPs because the funding gap leads to preferential terms, pricing, and risk. LPs looking to invest may be able to originate some high-quality deals during times of high volatility.
Recapitalizations are seeing more LPs bowing out
In the PERE market, more LPs are taking their money and going home. In 2022, recapitalizations accounted for 77% of the volume of real estate secondaries. Now, more LPs are choosing to liquidate and get out rather than stay in.
“Oftentimes, these recapped assets or portfolios or companies are assets that the manager wants to continue to manage and thinks have long-term value,” said Bill Thompson, Co-Head of Evercore’s Real Estate Capital Advisory business. “What’s actually happening in this market is a number of investors are electing to take the liquidity option.”
Because PERE can involve low liquidity — and because of the tumultuous times — many LPs are taking advantage of recapitalization to opt for liquidity. In 2021, the number of exiting LPs was 64%. In 2022, it reached 78%.
But that doesn’t necessarily mean reaching toward liquidity is the safe bet. Some LPs may be reaching for liquidity for other reasons, and a recap is only the most direct mechanism available to them.
Despite everything, PERE dealmakers are still optimistic
A survey of real estate dealmakers found that 52% were pessimistic or uncertain about the current PERE market, while 48% were upbeat. However, long-term sentiments were much higher: 75% percent reported being cautiously optimistic or optimistic about the next 12- to 36-month period.
According to the same survey, PERE dealmakers are focusing on off-market deals and distressed or restructuring deals. These survey results indicate that PERE dealmakers recognize the market is choppy, but believe it will recover within the next 1 to 3 years.
Despite this optimism, most PERE dealmakers have cited that they’re going to pause or draw back on M&A activity during this time. For these PERE dealmakers, the time might be right to reassess their current practices for process and pipeline management.
Navigate the chaotic world of modern real estate with DealCloud
As a whole, the PERE industry remains optimistic: It’s a volatile time, but PERE dealmakers have seen and overcome volatile times before. And there are still opportunities available, even during times of high volatility.
For GPs and LPs, real estate credit is an attractive investment, and its scarcity now provides more favorable terms. To take advantage, PERE dealmakers must diversify their lending options, from credit unions to individual investors.
DealCloud can help. DealCloud is an all-in-one deal management platform for CRE, supporting PERE dealmakers, real estate investment trusts (REITs), real estate trust fund management, and real estate operations.
Purpose-built for real estate, DealCloud offers:
- Centralized deal management: Manage both property and investment deals in a single space
- Property and portfolio analysis: Analyze your real estate deals, portfolios, and lenders to identify the best opportunities
- Deal and legal document management: Quickly secure deals and funding by streamlining your legal processes
- Due diligence and conflict management: Move multiple deals forward at the same time without losing track of potential roadblocks
Schedule a demo of DealCloud today to learn how you can better support your PERE dealmakers.