Private Equity Will Drive More Transaction Activity This Year
Private equity companies have transitioned the business model to perpetual life vehicles, and it is creating a lot of buying power in real estate.
One sign that the commercial real estate industry is nearing full recovery: record transaction volumes. Last year, transaction activity came roaring back, breaking new records in multifamily and industrial and showing strength in retail and office. Non-traditional assets have also been wildly popular this year as capital searches for opportunities.
Private equity has been a key contributor to this activity, and will likely continue to fuel transaction activity this year. These firms have transitioned their business plans into perpetual life vehicles, according to Cedrik Lachance, director of research at Green Street. “There is a lot of equity going into those vehicles, so undoubtedly it is creating activity. That activity is compounded by the debt availability, which remains significant at attractive prices,” he tells GlobeSt.com.
From a valuation perspective, the move makes sense. “Investor will pay more for the fee generated from a perpetual vehicle than one that must be sold after five-to-seven years and then must be sold again,” says Lachance, adding that REITs operate under a similar model.
So far, private equity companies are sticking the right balance. Lachance hasn’t seen any concerning underwriting standards akin to the years that led up to the Financial Crisis, but he has seen 70% to 75% LTVs become more common. “The ability to lever up comfortably creates a lot of buying power, and it is a buying power that sustainable and should last,” he says.
In addition to perpetual life vehicles, private equity companies are also investing in operational capabilities, which is creating stability for these business models long-term. “This is a tweak to the business model that allows them to create permanence in terms of the operational skillset, and there is the ability to create more value over time. It is a lot like a public company. The REITs are structured this way,” says Lachance.
Another upside—stable cash flow. “This structure also provides sustainability on the fee stream, and that is important to shareholders,” says Lachance. This investment approach is likely to become a standard in the market, supporting more buying power for commercial real estate.