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Real estate

The smart value-add investor – 2024 edition

Stefan Wundrak
Head of Research, Real Estate, Europe
Haoran Wu
Senior Research Associate, Real Estate, Europe
Skyscrapers and the sky above

When the market turned decidedly negative in early 2022, the strong value-add investment opportunity in the wake of the global financial crisis (GFC) came back to mind for many and inspired a number of real estate players to repeat that success. Substantial amounts of capital have since been raised, but very little of it has been invested to date.

The value-add playbook of the post-financial crisis era was to acquire properties below fundamental values from financially overstretched owners and leverage them with cheap debt. The recovering economy took care of vacancies while rental growth resumed. Exiting to cash-rich core investors, historically low yields delivered very attractive returns. Arguably, the results were a reward for bold market entry rather than any particularly strong effort by the new owners in the holding period. That game is not working in the current downmarket.

The root cause of this market reset is different, hence the treatment will have to be different as well. The last two down markets (dot.com bust and GFC) were characterised by a mixture of financial market and occupier market stress, relieved by central banks lowering interest rates. This time round, conditions are the polar opposite, with substantially higher interest rates being the trigger and occupier markets remaining resilient. 

Value-add investors will need a different set of tools fit for this new environment:

The turbulence as financial markets rely on cheap debt has been exposed and will create winners and losers and plenty of opportunity for conviction investors, as long as they are not shying away from complex workouts. A simple buy-low-sell-high approach will not cut it in this environment.

The question remains as to why this process has not started yet? By summer 2023, distressed sales remain near historical lows. Additionally, market yields look like they are getting closer to plateauing, while rental growth slowed somewhat in many sectors, but has not gone into reverse; even offices report continued rental increases.

Chart: Balance between stabilisation and repricing

There are good reasons to believe that this is a false dawn. The key is held by the lending sector: Real estate has not got an issue with fundamentals but with finance. Regulation brought in after the GFC made it much less attractive for lenders to try sitting out breaches. Low-cost loans from the years prior to 2021 will only slowly reappear for refinancing, where borrowers will be exposed to the hard reality of higher financing costs and lower leverage. It will also start to dawn on distressed borrowers that hanging on a little longer will not save them as the forward curve points to falling short-term interest rates, but also indicates that longer-dated debt will not become any more affordable in the foreseeable future.

Chart: How did it evolve over cycles?

The matrix groups more than 20 indicators into seven themes relevant for real estate market health. Fundraising looks at dry powder available to invest in private real estate and liquidity measures the actual volumes being traded. Sentiment shows investors views on the market, while the discounts/premiums on public markets are used as a measure of financial market’s view on real estate. Pricing measures relative value of private real estate versus other investment sectors. Real Estate performance reflects returns achieved in real estate and occupier gauges the underlying health of tenants and the space demand supply balance.

A variety of metrics analysed by Nuveen Real Estate further support this view:

The approaching refinancing reckoning is unlikely to cause an all-encompassing real estate market slump, as occupier markets and the economy are structurally too resilient for that, but for many market participants the deck is about to be reshuffled. Value-add investors will have the opportunity to play a key part in building new market foundations.

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