Private Equity Eyes Distressed US Real Estate Amid Market Turmoil
Driving the news: Distressed investors see a golden opportunity in troubled US real estate as the commercial property market continues to tumble. Private equity (PE) firms are positioning to capitalize, with 64% of their $400 billion in dry powder earmarked for North America — the highest share in two decades, according to Preqin data.
The big picture: The US market's strong bias could mean other regions might struggle to attract similar demand, delaying recovery efforts for troubled loans and properties globally.
- Deep discounts: American office values plunged by almost 25% last year due to the pandemic-driven work-from-home shift, outpacing declines in Europe. With nearly $1 trillion in commercial real estate debt maturing this year, rising defaults will create more buying opportunities for distressed assets.
- Global context: The focus on US opportunities might leave other regions with lower offers, potentially dragging down values in Europe and Asia or stalling market movements as sellers and lenders resist lowball bids.
What they’re saying:
- Rebel Cole, Florida Atlantic University: "Compared with the Savings & Loans crisis and 2008, we’re still in the first or second innings of troubled assets. There’s a tsunami coming, and the waters are pulling out from the beach."
- John Brady, Oaktree Capital Management: “We could be on the precipice of one of the most significant real estate distressed investment cycles of the last 40 years. Few asset classes are as unloved as commercial real estate, making it ripe for exceptional bargains.”
Market dynamics:
- North American advantage: A strong economy, deeper markets, and currency strength could contribute to a delayed recovery outside the region, according to Omar Eltorai from Altus Group.
- Lending retreat: Rising borrowing costs and plunging values have driven lenders away from commercial real estate, with a $150 billion gap between loan maturities and new credit availability this year, estimates PGIM.
Zoom in: Smaller lenders are particularly vulnerable due to their real estate exposure. New York Community Bancorp, for example, needed over $1 billion in capital injection earlier this year amid mounting financial challenges.
- Potential fallout: Oaktree analysis suggests that if commercial real estate values drop by 20%, the number of at-risk US banks could exceed 2008 levels. Office values fell 23% last year, according to the IMF.
Investor caution: Despite the appeal of US opportunities, the overall pool of PE capital for commercial real estate has shrunk. Money set aside for real estate debt strategies globally fell by 26% to $56.1 billion through May from the end of 2021, per Preqin data.
- Charles McGrath, Preqin: “Dry powder is declining. Higher borrowing costs mean private equity players are seeing a sharp decline in fundraising and transactions.”
Regional disparities: European concerns include doubts about the accuracy of real estate and loan valuations. The European Insurance and Occupational Pensions Authority noted in June that valuations might not reflect true asset worth, especially amid changing market conditions.
- Germany's lag: German banks update building valuations less frequently than US peers, delaying the surfacing of problems. The region’s banking supervisor notes €160 billion in CRE debt with a loan-to-value ratio over 100%.
What’s next: A significant wave of defaults and asset sales looms, though the debt structure means it might take years for the full scale of the trouble to appear. European Banking Authority Chair Jose Manuel Campa warned of a rising trend in non-performing loans that isn’t short-term.
Bottom line: As private equity firms target distressed US real estate, global markets may face prolonged challenges, underscoring the uneven recovery in the commercial property sector.
