PErspective in Real Estate - Fall 2015

October 2015

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Real estate private equity funds are having a prosperous 2015, with purchasing power and capital distributions at record highs. At the midyear point of 2015, private equity real estate funds had amassed
 $254 billion in dry powder, a 37 percent increase over the end of 2014. In addition, Preqin reported that real estate-focused funds have steadily increased their distributions since 2009, returning a record $187 billion to investors in 2014 alone. With opportunities proliferating for both profitable exits and reinvestment, PE real estate funds are well-positioned to close out the fund cycle they began between 2006 and 2008 – before the Great Recession – and begin anew.

High property valuations appear to be the primary driver of recent real estate exit activity. The Wall Street Journal reports that commercial real estate prices have reached some of their highest points since the market collapsed in 2008, thanks to continued low interest rates and rising demand from buyers for high-performing assets. According to Real Capital, New York City’s average commercial real estate capitalization has reached 5.7 percent, more than double the yield on a 10-year Treasury bond. 

For PE firms evaluating real estate investment options for their current fund cycles, the retail sector may offer promising opportunities. As consumer demand increasingly moves toward omnichannel shopping experiences, many retailers are seeking to shrink their square footage and cash in on their real estate assets. According to McClatchy News, Sycamore Partners’ $3 billion Belk buyout may provide the firm the opportunity to quickly recoup part of its investment through a sale-leaseback arrangement – in which Belk would sell its real estate assets and then lease them back from the buyer. Other retailers, such as Macy’s, are exploring options for spinning their real estate assets into other investment vehicles, including REITs and potentially private real estate funds (see our own Stuart Eisenberg’s recent column in Commercial Property Executive for more information on these spinoff deals).

However, while opportunities abound, real estate fund managers face increasing regulatory scrutiny, with the SEC's Private Funds Unit undertaking a thematic review of the real estate fund industry in 2014. In a May 2015 speech, Marc Wyatt, acting director of the SEC’s Office of Compliance Inspections and Examinations, pointed to potential changes ahead: Fund managers who offer ancillary services, such as property management, construction management or leasing services, may be expected to justify their fees.

The trend of surging real estate exits – and subsequent reinvestment in new real estate funds and opportunities – could very well continue through the end of 2015. Amid recent stock market turmoil and global economic uncertainty, the Fed seems disinclined to raise interest rates, making the higher returns of real estate private equity funds more attractive than ever. PE funds that can effectively navigate both the changing regulatory environment and the volatile economy may be poised to cash in again in five to seven years’ time.

PErspective in Real Estate is a recurring feature exploring the role of private equity in the real estate industry.