Deal value and volume fell during the fourth quarter of 2019 compared with the prior quarter amid ongoing geopolitical tension, a decline in cross-border capital flows, and the prospect of tougher regulation from the local to the federal level.
Despite a decline in activity during both the final quarter and full year, we expect the real estate market to show strength during the months ahead. The appetite for real estate assets among private equity investors, insurance firms, and retail investors remains strong. Also, with interest rates lingering just above historic lows, investors are seeking higher yields through a broader variety of investment themes, including the emerging focus on experiential assets.
“Faced with a challenging operating environment with rising political and geopolitical tension, our industry saw continued strength in deal activity as 2019 concluded. While we expect this strength to continue throughout 2020 and beyond, we believe the sector will be forced to navigate these tensions and take into consideration within their underwriting and otherwise the effects of climate change and a shifting regulatory landscape.”
The total volume of real estate deals fell 18.2% during Q4 2019 compared with the third quarter. At the same time, deal value declined 5.8% during the fourth quarter compared with Q3 2019. These declines followed solid volume growth during the prior six months. For all of 2019, transaction value declined 4.8% compared with 2018, an especially strong year. Nevertheless, the total value for 2019 exceeds the level for 2016 and 2017. Average deal value continued to rise during the fourth quarter, increasing 15.1% compared with the prior quarter and 8.1% compared with Q4 2018.
Transaction value in the hotel property sector continued its strong performance during the second half of 2019, increasing 4.5% during the fourth quarter on the heels of Blackstone’s acquisition of Bellagio Hotel & Casino. Deal value in the office sector increased 12.8% compared with Q3 2019.
Sector data for all of 2019 tells a different story. The value of industrial property deals rose 13.1% in 2019 compared with 2018. Yet nearly all other real estate sectors logged a decline in transaction value in 2019. The value of retail property deals slumped 31.1% and the hotel sector declined by 15.5%, while the apartment sector fell by less than 1% and the office sector rose by 0.1%.
Cap rates have remained steady for several quarters. Equity investors benefited after the Federal Reserve trimmed the benchmark interest rate three times in 2019. We expect low borrowing costs to support demand for real estate in 2020.
Closed-end real estate private equity funds raised a record amount of capital in 2019 and dry powder remains at record levels. During 2019, 194 funds focused on investments in North America raised $103.4 billion, pushing up the average size of closed-end funds to $655 million, according to Preqin. This far exceeds the previous record average of $450 million set in 2008. Capital raising activity in 2019 was partially driven by a handful of megafunds that closed during the year. This is likely indicative of a trend in which fewer managers attract the majority of capital.
Similarly, fund raising by public REITs from January through November 2019 hit $107.3 billion, or nearly twice the total for all of 2018 and 7% higher than the previous peak in 2017. As in prior years, unsecured debt made up more than half of the 2019 total. Unlike previous years, secondary common equity offerings far exceeded preferred equity fundraising. Six common equity fund raisings collected more than $1 billion. The largest—$2.5 billion gathered by VICI Properties—underscores steady investor demand for experiential real estate.
While private capital raising increased in 2019, cross border investment fell. During the first nine months of 2019, cross border investors accounted for 10.5% of total transaction value on a trailing 12-month basis compared with an average of 14.3% since 2015, according to RCA. Moreover, cross border investors last year were net sellers for the first time since 2012.
This decline in cross-border capital flows may underscore a broader change in strategy. An increasing number of investors are targeting core and core-plus strategies, according to a third-quarter survey by Preqin, while the proportion of investors targeting value-add and opportunistic strategies is falling. This shift may be driven by the source and investment horizon of capital in the market, as well as some concern around yield pressures and pricing. Still, investor appetite for US real estate remains high, supported by low interest rates, the lowest US corporate tax rate since the 1930s, and the prospect of attractive returns relative to real estate and other alternative investments around the world. The changes in strategy suggest that activity in the core and core-plus sectors may increase while competition for higher-return investment products may decline.
We expect regulatory scrutiny of the US real estate industry to persist in 2020, continuing a long standing trend. Several legislative changes made in 2019 could shape real estate investment for years to come.
Laws focused on housing affordability have been a priority in many US jurisdictions, prompted by a widening gap between median housing prices and median household incomes. Rent control laws enacted in Oregon, California, and New York—and under consideration across the US—have put pressure on traditional multifamily investment. The measures have also created opportunities for middle-income housing and spurred growth in single-family rental housing.
At the federal level, the Treasury Department in October proposed an expansion of CFIUS jurisdiction over some types of real estate transactions, including some leases and transactions for undeveloped land. The proposed rules would create a “white list” for a narrow set of investors. The rules would also change regulations pertaining to non-controlling real estate transactions, a concern for investors outside the US who have channeled capital into US real estate. Overall, we believe that increased regulatory scrutiny—along with trade tensions, valuation uncertainty and the political landscape in light of the upcoming US presidential election—may create headwinds for foreign investors in US real estate.
The US real estate market reflects a full range of economic and social trends, from the ageing population and the rise of e-commerce to concerns about climate change and the likelihood of a downturn. As a result, investors weigh a broad array of factors before committing capital.
On one end of the spectrum, investors have pivoted to core and core-plus investments in search of stability and the optimal investment horizon. From Q3 2018 to Q3 2019, investors targeting core and core-plus strategies over the next 12-months surged by 27% and 54%, respectively. Meanwhile, capital channeled to traditional value-added strategies declined. Investors have also turned to secondary and tertiary markets as cap rates have compressed in US gateway markets.
Asset managers are exploring new entry points into real estate as part of efforts to boost assets under management. They are expanding their market footprint by either acquiring smaller platforms or purchasing noncontrolling interests.
Real estate investors face pressures from the cost of labor and internal administration. As a result, many investors seek greater operating leverage by consolidating or centralizing operations. (Private equity firms have pursued a similar strategy by shifting to a shared services model.)
Shifts in tenant expectations have jolted the real estate industry. In the hospitality subsector, investments in experiential real estate dominated deal activity in 2019. In one high-profile transaction, Blackstone invested $2.9 billion in Great Wolf Resorts and spent $4.3 billion on its purchase of Bellagio.
Disruption from technology persists across the real estate industry. Industrial real estate has especially benefited from this trend, as e-commerce fuels demand for logistics facilities. Most recently, online retail sales hit a record during the holiday season.
The real estate industry is attracting capital from a broad variety of sources despite regulatory, economic, and geopolitical headwinds. We expect that new entrants will continue to invest in the market even amid any short-term decline in transaction value or volume. For example, insurance companies will probably expand their real estate investment even further in coming quarters.
With interest rates hovering near record lows, investors are seeking yield in new markets using new product types. Quickening activity in secondary markets and resilience and innovation in the industrial sector are just two trends that will likely keep the real estate market strong during the months ahead.
The information presented in this report is an analysis of transactions in the real estate industry where the target company (or asset), the target ultimate parent company, the acquiring company, or the acquiring ultimate parent company was located in the United States of America. We have based our findings on data provided by industry-recognized sources. Transaction, capital-raising, yield and property fundamental data (as applicable) was sourced from Real Capital Analytics, NAREIT, NCREIF, S&P Dow Jones Indices, PwC Real Estate Investor Survey ®, and Emerging Trends in Real Estate ®: US and Canada: 2020. Private equity real estate data was sourced from Preqin.
Transactions are based on the closing date, unless otherwise specified herein. Transaction volume is based on independent reports of properties and portfolios $2.5 million and greater. Data classified as retail relates to strip shopping centers (neighborhood and community), with the exception of transaction volume which includes all retail sub-sectors. Certain data is based on preliminary activity reported for Q4 2019. Percentages and values are rounded to the nearest whole number which may result in minor differences when summing totals. Information related to previous periods is updated periodically based on new data collected by Real Capital Analytics for deals closed during previous periods but not reflected in previous data sets.
Real Estate Deals Leader, PwC US
Real Estate Acquisitions Leader, PwC US
Deals Partner, PwC US