Playing the right hand in real estate deals

March 10, 2017


By Tim Bodner, US Real Estate Deals Leader, Victoria Miretti, Real Estate Deals Director and Dan Boyce, Real Estate Deals Manager

In our year-end review, we highlighted several emerging trends dealmakers should be prepared for in 2017 and beyond, including a trend in cross-border investment in the US. While we saw 2016 US cross-border deal value down 5 percent and volumes declining by 4 percent, US property owners and real estate dealmakers have continued to benefit from prolonged global uncertainty and a low-interest rate environment due to the global “search for yield,” as capital from sources abroad is expected to continue to flood the US commercial real estate market.

Starting in 2012 and continuing into 2016, we have seen central banks across the globe adopt quantitative easing measures such as negative interest rate policies to spur growth within their economies. Certain central banks have since revised their monetary policy to rate targeting, however, economies in Europe and Asia are still faced with extreme secular stagnation. We anticipate the low economic growth environment to continue as a result of the uncertainty created by the fallout of Brexit and the US presidential election, as well as the uncertainty created by the new geopolitical landscape.

While the US Federal Reserve increased target interest rates late in 2016 and is expected to continue increasing rates in the near term, global target or negative yield policies are not expected to change. The global economic easing measures have left cross-border (non-US) investors with few options in deploying their “dry powder.” As a result of this disparity between the US and global monetary policies, we anticipate a continued flow of foreign capital to the US economy, and notably, to US commercial real estate.

As illustrated in the chart below, investment in US real estate property has increased every year since the financial crisis recovery began in 2009, through 2015. Although investment in 2016 did not reach the record highs experienced in 2015, investment in US commercial real estate remained strong. In closing out 2016 and embarking on 2017, we are anticipating high volumes of foreign investment in US properties to persist.

Entity investment is defined as a public privatization, private-private merger, private-public merger, and public-public merger. Portfolio investment is defined as two or more distinct assets that trade together between the same buyer and seller. Parks, complexes and neighboring buildings are not considered portfolios but counted as a single property.

As a result of rising demand for US commercial real estate assets, real estate owners and dealmakers alike are analyzing their portfolios for potential opportunities available in the market. According to Real Capital Analytics, 7 of the 10 top destinations for global capital in 2016 included major metropolitan regions in the US. In Cities of Opportunity 7, PwC’s publication assessing the urban regions around the world, New York (#6), San Francisco (#8), Chicago (#13) and Los Angeles (#14) all rank within the top 30 of global cities that drive world growth both socially and economically. Global investor focus in the US will undoubtedly continue and will provide opportunities for real estate owners and dealmakers alike due to the relevance and importance our cities have to offer the global economic landscape.

As we navigate the uncharted territory in this era of economic uncertainty, real estate owners and dealmakers should be mindful of issues they can encounter as a result of their environment:

1. Know what you’re holding: Having a real-time, deep understanding of your assets is critical. Acting on opportunities and properly assessing and mitigating external risks and threats to your long-term objectives is vital in navigating your business through times of uncertainty. In taking stock of your portfolio, consider the following:

  • What is your ideal portfolio capital allocation strategy and how do your existing assets fit into your long-term strategic objectives?
  • Have recent political or economic events resulted in a change in your tenant’s credit quality?
  • How are your existing tenants impacted by rising US interest rates and current market conditions?

2. Understand the regulatory environment: As a result of certain regulatory restrictions imposed on US banks such as Basel III and Dodd-Frank, many financial institutions responsible for real estate lending prior to the financial crisis are either unable or unwilling to provide debt financing to property owners due to the new risk-weighted capital requirements. To minimize cost of capital and the impact of the regulatory environment, real estate owners and investors must consider the following:

  • Less sources of debt financing are available from traditional financial institutions which has led to a rise in alternative lenders, such as mortgage REITs, who may require a higher yield on commercial real estate loan investments.
  • Rising interest rates in the US may result in less capital available for operating and investing activities for the portfolio.
  • Values of underlying properties may have risen to a point where capital structures required to borrow funds may not be achievable to re-finance assets at maturity.

3. Assess your hedging strategies: Although the US Federal Reserve recently increased their target interest rate, global negative interest rates have impacted the way financial institutions are structuring the terms of their financing arrangements and financial products. Borrowers using variable rate financing to purchase assets, who may have also purchased interest rate swaps in order to hedge their variable interest payments, may experience:

  • Earnings volatility resulting from the use of interest rate swaps to mitigate interest rate risk as a result of the low (and at times negative) global interest rate environment.
  • A higher cost of capital required by financial institutions to enter into financial products with additional complexity and protection.
  • Additional effort or considerations necessary in order to achieve hedge accounting, which may result in added complexity and cost.

As capital continues to flow into the US commercial real estate market due to global “search for yield,” successful owners and dealmakers are trying their hand at navigating today’s complex environment. Finding strong opportunities while mitigating risk is possible as long as you play your cards right in the rapidly changing market.

For more information, visit our Real Estate and Deals webpages >


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Contacts

Bob Saada

US Deals Leader Tel: +1 (646) 471-7219 Email: bob.d.saada@pwc.com

Neil Dhar

Tel: +1 (646) 471-3700 Email: neil.dhar@pwc.com