A generational reset in commercial real estate prices is in full swing, with conditions pointing to further declines, setting up strong vintage-year return potential for private funds with fresh capital.
KEY TAKEAWAYS
- We believe unlevered private commercial real estate valuations are down approximately 20% from their peak in Q3 2022, with conditions pointing to further declines.
- We have expected this private real estate price adjustment and expect peak-to-trough declines to reach –25% to –30%, likely in early 2025.
- The question reflected in recent headlines is whether all private real estate valuations reflect the reality of a market that is repricing and has pockets of distress.
Recent headlines questioning private real estate valuations have brought into focus a key point we have been arguing for some time: A generational reset in commercial real estate (CRE) prices is in full swing.
We believe unlevered private CRE valuations are down approximately 20% from their peak in the third quarter of 2022, with conditions pointing to further declines. Our analysis of appraisal cap rates by property type, compared with listed REIT implied cap rates, suggests that peak-to-trough declines will likely reach –25% to –30%, likely in early 2025.
We have expected this private real estate price adjustment, given that listed REITs are a leading indicator for private CRE prices in both downturns and recoveries.
Indeed, listed prices declined when private real estate was still climbing in 2022. Subsequently, listed real estate appears to have bottomed in the third quarter of last year and is now recovering, while private is still in the process of finding its bottom. Listed REITs have outperformed private real estate, as measured by the NCREIF ODCE index, by nearly 33% over the past 6 quarters through Q1 of this year.
We indicated late last year that the private real estate market was only partially through its price adjustment, with a bottom likely to be reached toward the end of 2024 or possibly in 2025. (See our earlier analysis on this topic Private real estate set up for attractive early cycle returns.)
We still hold this view, and we believe the market environment is setting up for strong vintage-year return potential for private real estate funds with fresh capital—and for listed REITs, which will be able to take advantage of acquisition opportunities due to their favorable access to cheaper debt and equity.
Historically, the best vintage returns are generated in the aftermath of a cyclical downturn and when credit has repriced and is relatively less available.
The question reflected in recent headlines is whether all private real estate valuations reflect the reality of a market that is repricing and has pockets of distress.
Our view is that, while fundamentals remain on solid (albeit decelerating) footing, valuations continue to be pressured by higher financing costs and more restrictive lending conditions. We believe the next leg lower in CRE property prices will be driven by rising distress.
Legacy core real estate funds—particularly those with significant exposure to property types that were acquired at historically low cap rates (such as industrial/warehouses and multi-family apartments) and/or sectors with deteriorating fundamentals and oversupply (such as office)—are likely to face increasing pricing pressure.
Cohen & Steers has laid the groundwork to take advantage of the opportunity presented by this market regime shift. The launch of two private real estate strategies is solidifying our position at the intersection of listed and private real estate.
In private real estate, we are unencumbered by legacy assets and ready to invest fresh capital as the market reaches its cyclical bottom, creating the potential for strong returns and high yield. Specifically, we are seeing attractive pricing in previously out-of-favor sectors—notably, retail properties such as grocery-anchored and open-air shopping centers.
We believe this is also an opportunity to restate our views on private real estate valuation best practices.
While there are pros and cons to any valuation methodology, we believe a best practice is to have valuations provided first by an independent third party (and subsequently reviewed by the investment advisor).
We believe starting with an independent valuation—an external view that leverages wider market intelligence—helps facilitate consistent and unbiased appraisals and valuations for investment vehicles.
FURTHER READING
The Real Estate Reel: How institutions are invested in real estate headed into 2025
More investors are allocating to REITs, as listed and private real estate repriced and more investors seek liquidity.
The Real Estate Reel: Private real estate turns positive for first time in two years
The increase in total returns for private real estate was modest, but we think it is notable for several reasons.
The Retail Apocalypse is over; The Retail Renaissance has arrived
Reports of the death of the store were greatly exaggerated.
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Risks of investing in private real estate. Private real estate investments are illiquid and susceptible to economic slowdowns or recessions and industry cycles, which could lead to financial losses and a decrease in revenues, net income and assets. Lack of liquidity in the private real estate market makes valuing underlying assets difficult. Appraisal values may vary substantially from a price at which an investment in real estate may actually be sold.
Risks of investing in real estate securities. The risks of investing in real estate securities are similar to those associated with direct investments in real estate, including falling property values due to increasing vacancies; declining rents resulting from economic, legal, political or technological developments; lack of liquidity; lack of availability of financing; limited diversification; sensitivity to certain economic factors, such as interest rate changes and market recessions; and changes in supply of or demand for similar properties in a given market. No representation or warranty is made as to the efficacy of any particular strategy or fund or the actual returns that may be achieved.
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