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2017 Global Market Outlook

Trends in real estate private equity

As we move into 2017, there are many signs that real estate funds have been in something of a golden age over the last few years. As last year played out, closed-ended funds had record amounts of dry powder at their disposal, with managers worldwide holding US$239b to deploy (at December 2016), up from US$210b in 2015 and significantly higher than a decade previously, when the figure was just US$132b, according to Preqin figures.

As these statistics demonstrate, the fundraising market has continued to be robust as all types of investors, from pension funds and insurance companies through to sovereign wealth funds and family offices, increase their allocations to real estate. Many now allocate between 8% and 10% to the asset class, and their quest for yield in a persistently low-interest-rate environment, and an era of loose monetary policy, is leading to real estate investing representing around 10% of the economy in many markets. They are attracted by returns that offer a better reward than the negative yields now seen in many fixed-income investments.

At the same time, the asset class has not disappointed, as distributions from funds have reached record levels over the last three years. Indeed, 90% of LPs said the performance from real estate private equity funds had exceeded their expectations over the last year, according to a Preqin survey. It is little wonder, then, that re-up rates are high: around 90% for larger funds, and in the high 80s even for smaller ones.

And as appetite for the asset class shows little sign of abating, some firms are increasingly offering investors a choice of ways to access the market, expanding into new areas, such as monetizing a portion of the manager, broader co-investment opportunities, and open- ended debt funds.

This demand for real estate and innovation in product offering is overlaid with emerging levels of technological innovation filtering through to the market, with smart buildings enabling incremental but significant cost and efficiency savings, new technologies such as robotics and artificial intelligence improving back-office operations, and big data and analytics providing a level of granularity of information that has the potential to open up new windows of investment opportunity and change the way strategies are identified and executed.

And yet ... there are many in the market who would question whether real estate is now starting to head toward its eight-year nemesis known as the real estate cycle. With so much capital directed toward real estate investment globally, managers face high levels of competition for the few deals that come on to the market. Investors also reacted to these concerns as 2016 fundraising dipped 15% from 2015 levels to US$104b.

As described in the section on global capital flows, not all markets are at the same point in the cycle. The diminishing role of easy money from central banks, coupled with early signs of inflation and growth, is exposing the market to a price correction of some kind. Investors in many markets are now highly cognizant that real estate may be in the late stages of the cycle. With the traditional 10-year fund life, new capital raised is likely to experience some ebb in what has been a one-way growth trajectory in values. Signs of market stress are already appearing as US REITs are trading down on last year’s levels and the National Council of Real Estate Investment Fiduciaries index declined through 2016, following several years of rising returns.

The handoff from monetary policy to fiscal policymakers will become ever more important, as the levers that drive NOI growth will need to keep pace with investors’ demands for higher yields via expanding capitalization rates. The policies that emerge from a Trump administration, Brexit and Abenomics will all be critical to understand when devising global investment plans.

So, while there is much to suggest the real estate fund market is on solid footings, we are expecting some fault lines to show as 2017 progresses. Set against this context, we hope our Global Market Outlook for this year will provide some food for thought in advance of some interesting times ahead.

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