COVID-19 has undoubtedly had a seismic impact on the global real estate industry. In the short term, we’ve seen an inevitable hiatus in deal activity (depending on whose report you read, global investment volumes for H1 2020 have fallen between 30 per cent and 40 per cent below H2 2019 levels), largely stemming from the practical difficulties associated with diligencing and valuing assets at the current time. Looking forwards, it is clear that the pandemic will continue to act as an unparalleled disruptor on the industry at large, catalysing various sector trends which, while known about before lockdown, were still then in their infancy (e.g., the flight to logistics and Big Data, and the repositioning of office, retail, and residential). In so doing, COVID-19 is unquestionably giving rise to existential challenges, but it is also presenting matchless opportunities for those that are positioning themselves closest to the new centre of gravity that will emerge from its disruptive force.
It is no surprise, then, that many of the world’s largest and most successful real estate investors (Blackstone and Brookfield, to name but two) appear to have spent lockdown busily calling capital from existing LPs and JV partners, and, indeed, raising new funds – in other words, amassing the dry-powder they will use to ignite the opportunities revealed in the aftermath of the pandemic.
What this tells us is that, although deal activity has necessarily dipped in the short term, underlying demand for global real assets remains resolutely strong, particularly among the elite institutions that make and move the market. This should come as no surprise. In a world characterised by unprecedented economic uncertainty, it stands to reason that investors will tend to pivot towards assets such as real estate that (in spite of the tectonic shifts going on around us) retain their ‘safe haven’ status across most subsectors. This is doubly true, given that interest rates are set to remain at historic low levels for the foreseeable future, thus rendering many other investment classes (particularly fixed income) less rewarding.
What this means is that the industry is going to bounce back; and, when it does, we think there will be a major uptick in the following deal structures:
- Sale and leaseback – as government support schemes start to be discontinued, many companies will find themselves with urgent funding needs, but their conventional sources of liquidity (bank debt, capital markets) are likely to remain severely constrained. This misalignment will inevitably lead to companies seeking alternative sources of funding, such as sale-and-leaseback. In its simplest form, this sees an owner selling a property to an investor, who simultaneously leases the property back to the original owner, on an FRI/triple-net basis, for a long term (e.g., 20-30 years), and usually with regular fixed or inflation-linked rent increases. Thus, the owner is able to monetise 100 per cent of the value of the property, while remaining in long-term occupation and (to some degree) control. From the investor’s perspective, it has achieved a long-term, stable income stream, from a tenant with a strong covenant, which is thus somewhat akin to a bond, but with the added benefit of capital appreciation if the underlying value of the property increases. These structures have been steadily growing in popularity, globally, over recent years – in part due to the efforts of major global investors such as WP Carey who have placed great emphasis on them. Notwithstanding an inevitable dip in H1 2020 (tracking the wider market), we expect to see a strong uptick in their use as market activity resumes, given their unique attractiveness to both owners and investors at times of constrained liquidity.
- RE secondaries deals – in the years since the financial crisis of 2007-2008, there has been a considerable upsurge in global real estate investment activity. Most major institutional investors now have an allocation to real assets and, in many cases, this has been steadily increasing year-on-year. Many deals are being done on a cross-border
basis, and at every level of the capital stack. What this means is that many such investors are now holding relatively illiquid positions in private real estate debt and equity that, since the emergence of COVID-19, have, or are likely to, become distressed. To date, the level of trading activity in RE secondaries markets, although steadily growing, has been small when compared with mainstream PE secondaries markets. However, we think this is set to change, and that the aftermath of COVID-19 will witness a significant increase in RE secondaries deals. Indeed, many institutional investors are currently engaged in launching dedicated RE secondaries businesses (including Brookfield, who announced the launch of their own unit in July following the hire of two ex-Partners Group employees) so as to position themselves in readiness for this.
- JVs and club deals – many (and perhaps the majority of big ticket) real estate investment and development deals are now done under a JV or club structure, where funders, landowners and asset/development managers join together to pool resources and expertise. The other key benefit of these structures is that they spread risk, and it is for this reason that we predict their use is set to increase, as deals start to be done in the uncertain world that faces us as we emerge from the pandemic.
So, for different reasons, these are three key trends that we expect to see, in terms of real estate deal structures, as the market recovers.
We cannot predict when this recovery will happen, but we do know that, when it does, it will be hard and fast, as investors compete to deploy their dry powder at the bottom of the market into distressed assets in the sectors that show the most immunity to, or indeed that directly benefit from, the pandemic.
Client Alert 2020-485
