We use a top-down and bottom-up approach to develop our House Views, combining macro-economic, demographic, and geo-political factors analyzed by our market research team with the on-the-ground experiences of our investment team. Our investment team’s input is largely informed by our experience allocating over $20 billion of our clients’ and investors’ capital into real estate funds, secondaries, recapitalizations, and co-investments and through our 900+ meetings with real estate GPs in 2022.

As real estate adjusts to higher interest rates and slowing economic growth, conditions are ripe for a potentially extraordinary vintage period for non-core investing. Pressure on leveraged owners is creating appealing opportunities to buy assets from distressed sellers and to fund recapitalizations and secondaries. Debt investors benefit from higher rates, wider spreads and, as with the recaps and distressed purchases, the ability to be highly selective amid a growing pool of opportunity.

Real estate markets are correcting, slowly as usual. Challenges are driven by higher interest rates rather than operational dislocation in all sectors except office. Higher rates mean new loans are smaller and essentially require new ‘cash in’ to refinance or extend.

  • Further decline in indices is likely. Fund valuations lag, making it early to enter open ended funds. Repricing outlook varies by property type and location, with biggest drop for US office.
  • Trading volumes remain depressed and focused on smaller, high-quality assets in favored property types. Property owners’ growing acceptance of higher-for-longer interest rates is beginning to drive transaction volume. Lender focus on workouts at the expense of new lending slows volume.
  • Loan restructuring is underway. Leveraged owners must fill funding gaps to retain worthy assets. They will seek to raise money if they can’t fund internally. There will be motivated sales of troubled assets, of good assets to fill funding gaps on other assets, and of loans at potentially attractive discounts. We are likely to end this cycle with more non-bank lending.
  • New equity capital is limited. Non-core fund raising was down 50% in 2023. Fund valuations haven’t fully corrected, and a 68% drop in distributions leaves many investors fully allocated. While there is a lot of dry powder, much will be deployed to restructure existing assets.

The health of the various property types varies considerably.

  • The US office situation is far worse than other property types or office elsewhere. Secular trends exacerbate US office problems while dampening harm to others from cyclic slowdown. Office faces a long, hard road ahead and will continue to make headlines. Like retail, which is finding its footing over a decade after the advent of e-commerce, office will eventually restabilize, likely also at much lower prices.
  • Industrial, residential and a number of the niche property types will face cyclic challenges but unlike office, have secular lift and or supply/demand imbalances that will help sustain income and lead to more resilient returns.

StepStone Real Estate’s Margaret McKnight, Andrew Mitro, Anja Ritchie and Michael Humphrey present our Real Estate House Views. 

Download a copy of the presentation here.

 

Please direct questions to SREMarketResearch@stepstonegroup.com or reach out to your client manager.