The Risks and Rewards in Real Estate Investments

Following a tough year, the real estate market yielded a mixed bag with some sectors showing more promise than others.

Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

After a tumultuous year brought on by the pandemic, the real estate market is showing some signs of recovery — albeit slowly, with sharp contrasts between sectors.

On the whole: In 2020, the aggregate capital raised by North America-focused private real estate funds fell 26 percent from 2019, according to a Preqin U.S. real estate markets report published on Monday. For 2021, data gathered to April showed the total value of private equity real estate deals was equivalent to nearly 30 percent of last year’s total; though there may be an uptick during the latter half of the year, according to the report.

The country’s residential real estate sector has seen the most activity so far this year, totaling $17 billion in deals during the first four months of 2021 — partly due to the shift to remote working with people migrating to warmer and less expensive cities. The new homeworking trends, including the shift to less urban areas, are “already shaping investor demand and city rankings in terms of invested capital.” Some pension funds have already raised their target real estate allocation in the past year.

As companies introduce hybrid working options — where employees can work from home for part of the week — flexible working could continue to drive location decisions. The eventual return to the office will require less space and therefore produce a smaller demand for office real estate, according to the report. In 2020, 744 office private equity real estate deals occurred, a 49 percent decrease from the 1,465 deals in 2019. For the first four months of 2021, only 204 deals were completed. The figure for related funds was even more bleak: “Not a single U.S. office-focused fund has closed thus far in 2021,” the report stated. “That compares to eight office-focused funds that closed in 2020.”

But authors of the report caution against dismissing office real estate completely in 2021, noting that while there is reduced focus on this part of the market, it “underestimates the potential for funds investing across sectors in the U.S. to target offices.”

The retail sector stayed on a downward slope. In 2020, the volume of retail deals fell 48 percent from the previous year due to “weaker valuations, as well as investors becoming more reluctant to commit to the sector in a meaningful way during a period of rapid change,” according to the report. “Prior to 2020, this shift had already begun to hit valuations of retail properties, and this was compounded by a pandemic-led reduction in deal activity and investor interest.”

Unsurprisingly, the biggest winners in the market continue to be the country’s industrial and logistics sector. In 2020, asset allocators “benefited significantly” from stable rental income, and increased e-commerce activity uplifted asset valuations, according to the report. Researchers expect this upward trend to continue into the latter half of 2021. “Coming out of the pandemic, industrial real estate will continue its growth trajectory, as the economy returns to pre-pandemic levels of activity.”

As for the future of hospitality, a sector hit hard by the pandemic, one large deal could help turn the tide. The report highlighted the joint venture between Blackstone and Starwood Capital Group to acquire hotel company Extended Stay America as the deal that could change the outcome for 2021.

“Extended Stay America boasts a portfolio of around 650 hotels, which Blackstone and Starwood have been circling for several years even though both companies have previously invested in the hotel chain,” the report said. “Extended Stay was able to mitigate the impact of the pandemic by hosting guests such as essential workers for a week or longer at a time, maintaining occupancy rates well above the U.S. average.”

As the U.S. economy emerges from the pandemic, there is still “significant” real estate capital, according to the report. “Private equity funds continue to raise more capital, seeking the relative returns that only real estate can provide.”

But the money needs to be deployed selectively. “Investors must reassess their risk adjusted return projections for each market and sector, considering the recent economic volatility, evolving demographics, and changing patterns of space demand.”