Private Markets Outlook 2021
Opportunity in adversity
The immediate effect of COVID-19 on the global commercial real estate sector was a sharp decline in transaction activity: deal volumes fell by 55% in Q2 2020 compared to the same period last year. This decline was partly caused by an inability to perform due diligence while lockdown measures were in place and wide bid/ask spreads that encouraged sellers to hold assets for longer.
We expect an increase in activity in 2021 as potential negative year-end valuation adjustments get absorbed and sellers adjust their price expectations. In certain instances, however, we anticipate there could be deeper distress felt by both GPs and LPs, particularly those exposed to retail, hospitality and troubled office assets, with a fall in valuations and capital constraints leading to distressed sales activity.
There is a clear divergence in performance across various real estate segments. Logistics has been the relative winner. Strong growth in e-commerce has driven the demand for last-mile logistics, supporting rental levels. Office has been challenged as physical occupancy dropped significantly due to the crisis. In the residential sector, meanwhile, people continue to migrate to places where they have more space and can find relative affordability. Retail has also been hit hard as store front rental receipts fell materially during lockdown periods, exacerbating a sector decline that was already well established. Equally, for hospitality, lockdowns have caused hotel revenue streams to tumble.
Given today’s market environment, we take a very cautious outlook on rent growth in the short to medium term and maintain prudence in our underwriting assumptions, shying away from opportunities that do not meet our strict standards. As valuations adjust and bid/ask spreads narrow, we expect to see a material increase in opportunities in 2021.
For office and residential assets, it is too early to assess how remote and flexible working will impact long-term demand in metropolitan areas such as New York City, San Francisco and London. Nonetheless, we have conviction that growth cities, characterized by above-average population and employment growth, will continue to attract companies and people, driven by their lower cost base and favorable tax regimes relative to high-cost gateway cities.
The logistics sector continues to benefit from the growth of e-commerce, which has been accelerated by COVID-19. Retail and hospitality continue to be clear underweights. We expect the shift from bricks-and-mortar retail to e-commerce to continue to challenge the retail sector until rents stabilize at affordable levels and more leases convert to turnover-based structures. We also remain cautious of pursuing heavy asset repositioning opportunities in these sectors unless they are justified by high discounts, which we are generally not observing in the market at this time.