2023 Real Estate Fund Industry Expectations

2023 Real Estate Fund Industry Expectations

by Jason Gilbert
September 22, 2022

As we approach the last quarter of 2022, market trends and macroeconomic factors continue to influence real estate investments. To help fund managers identify investment opportunities and prepare for success in 2023, the following is a high-level analysis of how real estate has shifted in response to policy changes and today’s volatile environment.

Biggest Shifts in the Real Estate Market

The real estate market saw a lot of foreign investment dollars come back to the U.S. toward the end of 2021. This has continued into 2022, with foreign real estate investments back in full swing. Much of the money that had historically been put into commercial office properties has shifted to multifamily and industrial investments.

In the first eight months of 2022, these foreign investments put pressure on domestic investors to find opportunities for themselves and get deals done. There has been an abundance of dry powder, which is driving price increases. This, combined with the Federal Reserve recently raising interest rates, is making real estate even more expensive.

Policy Changes Affecting Real Estate Investments

The Federal Reserve’s decision to pull on one lever hasn’t done much to curb inflation. They’ve increased the interest rates, but they haven’t decreased the money supply. We can expect the Fed to continue to try and squash demand by increasing interest rates at their future meetings.

As of September 2022, we also continue to have supply chain constraints, which is causing a push-pull effect on the market. The supply struggles hold the prices high, which works against the efforts to bring prices down.

At this point, it’s a matter of waiting for the situation to unfold. Based on current job market statistics, our estimates indicate that recession is not likely within the next 12 months. Labor reports show that job openings and opportunities are still at an all-time high, leading us to think that we’ve got a bit of runway in front of us. This is an unpopular opinion, but the Fed will likely keep pushing on rates until unemployment starts to rise significantly. That’s the quickest way to drop demand in the market.

On the real estate side, with each rate increase it becomes more expensive to acquire and close deals. This means that those mezzanine and tertiary-type transactions are unlikely to happen. They’ll simply fall through because it becomes too expensive to get deals done.

When interest rates are high, fund operations also have to get lean to generate consistent profits. Thin margins cause banks to start pulling back or expect more equity in the deal to close a loan or provide financing.

Investment Opportunities for 2023

In the current environment, funds need to have a fundamentally strong underwriting due diligence process to find their investments and create opportunities for their buyers or investors.

From an asset perspective, this is where we see the best investment opportunities for the remainder of 2022 and 2023:

  • Industrial: With the continued growth of instant online commerce, there is increased demand for warehouses and storage closer to communities. However, it’s important to keep in mind that this sector has been hot for a while and at some point, the music stops. There are geos where these properties are overpriced.
  • Multifamily Residential: As people moved from the coast to other areas of the country during the pandemic, house prices became unaffordable. Rents are increasing in line with this higher demand and inflation, so there’s more money heading toward the multifamily sector.
  • Multi-Use Retail: COVID and the growth of online commerce have made it difficult for destination retail to recover. However, humans are social creatures, and there’s growing demand for shopping and dining. This creates an advantage for centrally located, multi-use properties that combine retail, commercial and residential spaces where consumers can gather to enjoy a variety of experiences near home.

How to Prepare Your Fund for Success

There are grumblings that we are at the threshold of a 2008 real estate moment with the run-up in prices, but we don’t think that’s true. There may be pain ahead, but not the level of fallout that happened in 2008 to 2010.

Either way, now is a good time for fund managers to take inventory of their house. You need to be deeply connected to your development and operating partners beyond the properties they’re related to. Making sure you understand the health of a partner’s overall business and operations can help you deal with issues before they become a larger problem.

Years of experience have shown us that once a property gets in trouble, fund managers have to move quickly. When push comes to shove, managers need to do what’s right for the limited partners (LPs) and the investors in the background.

In these cases, communication is everything. As soon as you see a significant change coming down the pipeline, it’s important that your LPs and investors understand what’s happening. Make sure you take proactive steps and develop an exit strategy with a pathway lined up to avoid further trouble.

In recent years, third-party administrators have stepped in as a way to put better controls in place and get the right systems to capture information. By having someone else involved with cash management and keeping tabs on a regular basis, there is a second set of eyes for distributions and statement production to increase security beyond annual audits. We’ve seen that LPs are starting to ask for more outside involvement before placing significant investments.

Well-run real estate funds can yield returns with better consistency than the stock market and a lower risk profile. Especially during times of flux and recession, it’s essential to put structures in place that increase transparency and support your fund’s strategy. By leveraging technology and streamlining operations, real estate investments can continue to be a safe haven for wealth into 2023.

If you have questions about what the future may hold for the real estate market, or you’d like to learn more about how to optimize your fund’s operating and back-office procedures, reach out to our Real Estate team.

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