“The impact of the rise of interest rates on the real estate sector, in the past 12 months was massive… with a rapid repricing of assets across all sub sectors…with more to come by year-end,” said Volker Kraft, managing partner at ECE Real Estate Partners. He observed that banks have become restrictive on the back of high uncertainty.
Far from being only a Luxembourg phenomenon, he noted that real estate developers, in general, have been “really struggling,” resulting in “a number of insolvencies; also, more is to come.”
In terms of performance, , managing director and head of the Luxembourg office at Macquarie Infrastructure and Real Assets, noted that “[the impact] of high interest rates have been partly offset by inflation.” In a year of negative performance for equities and bonds in 2022, she reported a performance of 8.2% for infrastructure. She thinks the asset class displays defensive attributes and protects against inflation.
Moderator Kavitha Ramachandran, chief operating officer Luxembourg for Apex Fund Services, reported the notes of Hans-Juergen Boehm, senior vice president at HPS Investment Partners, who could not be present. Boehm said that he observed “further growing inflow in private debt despite the macroeconomic uncertainties of high interest rates and inflation.”
Transactions and fundraising: A dry world in 2023
A common denominator in the various real estate sectors is the lack of transactions. “Not much has happened,” said Kraft.
“The fundraising environment has slowed down considerably, I think, to the lowest level of in the past 10 years,” said Kraft. According to Villalobos, the infrastructure market was also hit by low fundraising and it takes longer to achieve the target of the funds. Indeed, she reported that infrastructure funds raised $175,8bn of capital in final closes in 2022, whereas the asset class raised only $11bn in final closes in 1H2023.
In addition, Kraft commented that the issues described above were coupled with increasing uncertainties on regulatory matters in general and more specifically on “increasing implications of ESG regulations” that come “with capex requirements in existing portfolios.”
This is exactly the environment where opportunities arise… we’re getting ready for what I personally believe are going to be some of the most interesting vintage years for investing .
On the back of higher interest rates--and therefore lower bond valuation--Kraft noted that institutional investors have seen their exposure increase mechanically from, say, 20% to 25% of total assets, resulting in a reduction or an adjustment of strategic asset allocation. That source of funding has “fallen away.”
In addition, he explained that the switch from defined benefit plans to defined contribution schemes limits the ability of institutional funds to invest in all illiquid asset classes such as real estate, infrastructure, and private debt.
Retail and hotels: “the triple inflation hedge”
Despite all the challenges facing the real estate sector, Kraft thinks that “this is exactly the environment where opportunities arise… we’re getting ready for what I personally believe are going to be some of the most interesting vintage years for investing.”
Given the pressure from banks for lower loan-to-value ratio and higher investment requirements due to ESG, “someone needs to fill the gaps.” Yet not all investors have the capacity to inject additional equity and to provide debt funding.
Kraft sees a bit of growth in data centres and logistics, two darlings in the real estate world. Working for a family office-backed company, he can more easily adopt a contrarian view and focus on “beaten-up sectors (retail and hotel) during covid and during times of rising interest rates… they are by far the cheapest sub-sectors.”
Beyond being cheap, they are “better inflation hedges… than offices and residentials,” said Kraft. He explained that retail tenants typically pay the higher of a fully indexed rent, or a percentage of their sales. As a landlord, you can benefit, in some cases, of food inflation in the high teens. The context is the same for hotels, which benefitted from “skyrocketing” room prices. Importantly, he mentioned that tenants are very transparent in terms of data (sales figures, occupancy rates). In addition, one can easily add value by “working the assets.”
Infrastructure: the long-term view
On the back of public policies supporting infrastructure, Villalobos sees “a lot of opportunity and renewables and energy transition.” In particular, she reported that greenfield projects have increased renewables and the energy transition. The sector should be boosted in 2024 by the European Council’s adoption in October 2023 of the renewable energy directive 3, despite higher costs and delays on wind turbines.
In aviation, Villalobos noted that we are at 95.7% of the number of passengers seen pre-covid and 2024 should display figures last seen pre-covid, “despite China not growing as expected.” She also observed that toll roads are seeing higher traffic, with Latin America enjoying the strongest growth at 8%, Italy at 5%, France at 3% and the US at 2.4%.
In a turbulent market environment, the opportunistic investors come first, then the value investors are coming and finally, at some point in time, core investors will come back
Surprisingly, she goes as far as predicting a performance of 8.5% for infrastructure in 2024.
By the end of 2024, Boehm expects 75% of institutional investors to allocate capital to private debt, compared to 56% in 2022.
Villalobos noted that co-investment continues to grow which enlarge their opportunities without which they could not do alone due to various restrictions such as country or sector exposure. Similarly, Boehm suggested that investing “alongside private debt funds provided [institutional investors] greater transparency and diversification.”
Profile of current investors
“Yet the sources of capital are changing,” said Kraft. “In a turbulent market environment, the opportunistic investors come first, then the value investors are coming and finally, at some point in time, core investors will come back.”
He thinks that Anglo-Saxon investors tend to be amongst the first to see the opportunities in a difficult market environment. Moreover, as US investors are perceived as not overly allocated to the real estate sector, Kraft thinks that “they have the dry powder now to take advantage of the pricing dislocation.”
Moreover, he expects non-regulated investors such as private wealth and family offices “to come into play in difficult times.”