WASHINGTON, DC–Commercial real estate has a bid-ask gap problem — meaning that buyers and sellers are unwilling or unable to come to agreement on the price of an asset. There are a lot of factors that go into this logjam starting with the varying opinions on where the cycle is.
PwC's Real Estate Deals Leader Tim Bodner happens to believe that assets are fairly priced right now, largely because in most sectors operating fundamentals remain stable. Also, he tells GlobeSt.com, leverage is not anywhere near what it was in prior cycles.
Valuations Are Not Too Rich
But Bodner dismisses the notion that buyers have concluded that valuations are too rich. Rather, he says the bid-ask gap is more a function of the large amount of private equity that is circulating in the market, their cost of capital is — and what they are able to get from a return perspective, based on that cost of capital. “Your opportunistic funds generally have a higher cost of capital and so it is a lot harder with that cost of capital to get the yield to work where the market is,” he says.
“So it is not that people feel valuations are too rich — it is just more about the return these funds are able to get based on their underlying cost of capital.”
The sticking point has been that up until recently, say the last two years, opportunistic strategies tended to dominate private equity, Bodner says. These funds generally try to get somewhere between a 15% to 20% return on their capital. “And it's really hard given where pricing is and where their costs are to get that return from an opportunistic point of view.”
Innovations In Private Capital
But that has been starting to shift as the large players among the top 10 private equity firms — the Blackstones, the Brookfields, the Starwoods — are innovating on the product side. Essentially, Bodner says, they're creating strategies that are moving away from opportunistic capital to core or core plus capital, where the return thresholds are much lower.
At the same time for the last several years there has been a general shift in investors consolidating the number of managers with which they place capital, he adds. “Meaning the top tier funds are getting bigger and it is among those funds where we see this new product innovation because they're able to get the kind of capital allocation they need, versus the smaller folks.”
There are a number of ripple effects from this trend. One is that private equity will become increasingly bifurcated, with the smaller funds focusing on their traditional strategies as the larger funds innovate in new directions. The smaller funds aren't going away, Bodner says, but it is possible they won't be as active as they were in the past because of this rotation.
Another ripple effect of greater interest to CRE will be the growth of funds that have the latitude to meet sellers on price.
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Erika Morphy
Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.
