Lisa Knee is a tax partner and co-leader of the national real estate practice, and leader for the national Real Estate Private Equity Group, at EisnerAmper LLP. She has over 25 years of experience. also has extensive experience in the use of private REITs in fund structures.
The private equity real estate market experienced one of its best years in 2019 with over $400 billion in deals. How is 2020 likely to fare?
The good news for private equity funds is that they have a lot of dry powder to invest and can take advantage of distressed situations. In fact, many new funds are being created specifically for this purpose. However, most of these deals likely will not happen until 2021.
Despite the current environment, the largest fund names continue to attract significant capital in an environment of historically low interest rates. At the same time, overall deal volume is likely to slow further given current uncertainty over cash flow, cap rates, and values.
The bad news is that some funds that invested in the property sectors or markets that have been particularly hard hit by the fallout from the pandemic are taking losses. While there haven’t been enough transactions to navigate current values, some investments are being written off and at some point, the overall return of the fund may be insufficient to generate promotes for the sponsors.
What are some of the broad trends you have been watching across property sectors?
Given the rapid rise of online spending for all goods, the demand for warehouse and distribution centers continues to grow. If the response to the pandemic evolves into normal consumer behavior, this sector will continue to outperform.
So far, multifamily has outperformed expectations amidst the pandemic, with rent collections near historic norms; yet the longer it takes for jobs to recover—and we are only halfway there—the higher the risk for this sector to underperform. For example, there is already evidence that some tenants are using credit cards to pay their rent and that is obviously going to be a problem down the road.
We are seeing people leaving large cities like New York and San Francisco in favor of the suburbs, or to entirely new states. How does this impact residential REITs?
Apartment REIT prices have declined with the uncertainty over whether the recent shift from urban to suburban will be a temporary or permanent response to the pandemic.
Core urban centers will continue to be attractive places to live, as they prove to be a meeting place for social and cultural interaction and are a magnet for talent, which is where innovative companies want to be.
With potential long-term changes in the use of office buildings, some central business districts may be replaced by clusters of business activity around, and just outside, the large cities. These areas will be live-and-work types of neighborhoods with a strong demand for apartment living.
The single-family rental business has done well through the pandemic too as many people have opted to move out of urban centers temporarily or permanently. And many more have opted to rent versus buy in this environment while gauging what will happen to large city living in the future.
How is the increased reliance on online shopping affecting certain REIT sectors like grocery-anchored retail and industrial REITs?
Obviously with more groceries and consumer goods being bought online, we see a higher demand for additional distribution space nearer to the customer, otherwise known as the last mile of distribution, so the industrial sector will continue to flourish.
Despite many retail companies moving to a heavier online profile, grocery-anchored centers have held up better than some other retail segments as people still want to shop outside of their home for their basic needs.
With respect to listed REITs, most REIT prices have declined, and that decline is greater than the decline reported in private transaction values. That said, we believe it’s too early to tell whether the private or public markets are right about current values.
What does the future look like for sectors like office and hospitality REITs?
For both office and hotels, the recovery will be very dependent on the market and the composition of tenants or guests in those markets.
Currently, the office sector is perhaps the hardest to predict. While there is much speculation, no one knows how long-term office usage will actually be impacted post-pandemic, with so many businesses rapidly adjusting to a near-100% remote workforce.
How this will differ, city-by-city, is up for speculation. For example, we might see more hybrid working situations in a large city like New York. Hybrid meaning workers opting to work from home two or three days a week and the other days in the office.
For years, tenants have reduced the space per employee and densified offices. Now they will have to de-densify, but that may be done with more work from home options rather than greater demand for space. It is very difficult to know right now.
Hotels will likely have a long recovery, with fly-in tourist destinations, convention cities, and global urban hotels perhaps taking several years to fully recover. There will be a shorter recovery expected for smaller drive-to hotels in secondary and tertiary markets.
We have seen deal flow slowing dramatically since March. When will we start to see the ice thawing and deal pipelines in all sectors begin to increase?
Of course, that all continues to depend on the duration of the pandemic and the length of time it will take the economy to recover. Unfortunately, it all remains very unpredictable. Each survey we read seems to push back the timeframe for both social and economic recovery back and forth.
As we approach 2021, and certainly into the first half of next year, we will start seeing more distressed asset deal flow, particularly when lease and loan forbearance agreements expire, and the tenants or property owners haven’t recovered the cash flow necessary to keep operations whole. This will bring distressed property and loan sales volume higher.
Deal flow for core properties will return once there is verifiable price discovery, and there are already transactions for properties with really solid rent rolls that we are seeing presently.