What had been a relatively quiet year for private equity firms got a jolt in December when Blackstone announced it would sink $700 million into new data center developments.
To some, the deal almost sounded like a starting gun going off for an industry that spent much of the year sitting on nearly $300 billion to invest in real estate.
In 2023, U.S. property transactions involving private equity investment funds were down 45% compared to 2022, according to CoStar data. The industry's cautiousness was reflected in the abundance of "dry powder" — or unspent capital — held by investment funds. Blackstone, the king of real estate dry powder with a $66 billion stash, epitomized this trend.
But optimism is brewing. Jon Gray, Blackstone's president, hinted at a potential spending spree in the company's third-quarter earnings call.
“Ultimately, there will be real estate to buy and real estate to sell, and with our $66 billion of dry powder, I think we're going to be in a really unique position,” Gray said. “I mean, we raised this $30 billion plus global fund. I think we've invested less than 5% of that fund today. We have the vast majority of our Asia fund uninvested, and our Europe fund we're just raising, so by definition is uninvested. So, we think we're well-positioned in this environment, particularly if banks pull back and there are liquidity shortfalls.”
Dry powder alone doesn’t reveal the full tally of money that is sitting on the sidelines, Erin Patterson, global co-head of research and strategy at Manulife Investment Management, told CoStar News in an interview.
There is a lot of money unaccounted for yet, she said, from investors who don't want to put additional money into funds that aren't buying assets right now.
But conditions are ripening for deals to emerge in 2024. There's more clarity around interest rates having topped out, the predictions of a recession have receded and the underlying fundamentals in the commercial real estate market are generally in good shape, with the exception of the office market.
“We're settling into this norm. It is a general shift in sentiment, where sellers will start to come to market and that is what leads to price discovery,” Patterson said. “Once you have price discovery, then the financing and lending environment can start to respond. Once we have assets that start to go to market, and we have a response from potential buyers, then that kind of proves out that investors still want their capital in real estate.”
By strategy, the largest amount of dry powder is targeted at opportunistic investments, at $139 billion, according to CoStar data. Value-added is second at $84 billion, and debt funds is third with $40 billion and looking to raise $60 billion.
While the opportunistic strategy might be the largest bucket, the value-added strategy might have better opportunities in 2024. Opportunistic strategies often involve investing in new real estate developments, much like Blackstone’s data center development investments.
“Higher interest rates are impacting valuation multiples in the sector. This is also having the effect of meaningfully reducing the new supply pipeline, which is favorable for values longer term,” Blackstone’s Gray said in his third-quarter earnings call. “Construction starts are falling sharply for virtually all types of real estate, including year-over-year declines of 30% to 70% for US apartment buildings, warehouses, and hotels.”
Value-added opportunities are more likely to materialize over 2024, according to Patterson. Value-add buyers bring new capital, management and plans to a property to help improve its returns.
“We're going to see more distress coming due, and not just in terms of office,” she said. “It's just the reality that we have [interest] rate reset agreements coming due before maturities. Something like 40% of floating rate loans are set to expire in the first six months of 2024 alone, and to me, that is a value-add proposition.”
It will take time for sellers and buyers to agree on pricing in 2024, Joseph Rubin, senior advisor to the real estate services group at Eisner Advisory Group, told CoStar News in an email. He does not expect transaction volume to pick up significantly until the second half of the year.
“The pace of transactions will depend on asset class, with multifamily, self-storage, retail, and industrial properties having the narrowest bid-ask spread,” Rubin said. "The office market will remain dormant in 2024 as owners and tenants continue to seek the new supply-demand paradigm and identify the winners and losers.”
Next year won’t be all good times. The equity gap created by higher interest rates and tighter underwriting when refinancing debt could cause even greater distress than in 2023, Rubin said. That should open up opportunities for debt funds.
“Owners will lose properties to new buyers coming in," he said. “It will be a good time for private equity and other opportunistic investors to buy loans from banks and provide various forms of really expensive rescue capital to their borrowers.”