Wall Street Is Ready to Scoop Up Commercial Real Estate on the Cheap
Firms are raising billions of dollars for funds to target assets with slumping values
3 min
Wall Street firms are raising new funds to acquire office buildings, apartments and other troubled commercial real estate, looking to scoop up properties at a fraction of the price investors paid a few years ago.
Cohen & Steers, Goldman Sachs, EQT Exeter and BGO, formerly known as BentallGreenOak, are among the prominent names raising billions of dollars for funds to target distressed assets and other real estate with slumping values, according to regulatory filings.
“The last few weeks, I’ve been saying, ‘holy mackerel, they’re coming out of the woodwork,’” said Kevin Gannon, chief executive of Robert A. Stanger & Co., an investment-banking firm that tracks real-estate fundraising.
The new funds are seeking to capitalise on one of the most troubled commercial-property markets in decades. Values have nosedived since interest rates spiked last year, driving up borrowing costs in the highly leveraged business. The office market, one of the largest sectors, has also been clobbered by a sluggish return-to-office rate, which has sent vacancy rates soaring. Apartment buildings, an investor haven in the past, look vulnerable as owners try to refinance at much higher rates. Mall owners are contending with steep value declines, some of more than 70% over the past few years.
Commercial-property sales have been moribund until recently because most sellers haven’t been willing to cut their prices to the levels that buyers are demanding. Now, a small but growing number of office owners have begun to capitulate, unloading distressed properties.
The capitulation marks a new phase in the commercial real-estate upheaval, as more beleaguered property owners turn over properties to lenders or decide to take what they can get, rather than hold out hope for an eventual recovery. This wave of fundraising is the latest sign that sales activity is expected to increase as more sellers yield on price.
In one recent example, the owner of a downtown San Francisco office tower unloaded the property for $41 million to developer Presidio Bay. The seller, Clarion Partners, had purchased the property for $107 million in 2014.
While the clearest distress is in the office sector, many property owners with floating-rate debt may also feel pressured to sell at marked-down prices because they are unable to refinance at today’s higher rates. In addition, fund managers expect values to fall as regional banks, under pressure from this year’s rash of bank failures, unload commercial-property loan portfolios at discounted prices.
“There are selective opportunities beginning to arise for investors that are in a position to take advantage of weakness,” said Rich Hill, head of real-estate strategy for Cohen & Steers, which is aiming to raise more than $2.5 billion in a new nontraded real-estate investment trust.
Commercial-property values already have fallen about 10 to 15 percentage points from their peaks in the third quarter last year, and might fall a total of 20 to 25 percentage points, said Hill. “You have to go back to the [savings and loan] crisis and the global financial crisis to see such big declines in property valuations,” he said.
The volume of distressed commercial real estate grew by $8 billion in the second quarter, reflecting the rise in cases where the owners defaulted or lenders foreclosed, according to data provider MSCI Real Assets. That is the biggest quarterly increase since the second quarter of 2020.
While most of the new funds are looking to buy property, some are planning to lend to property owners and fill the void left by the cutback in activity from regional banks and mortgage real-estate investment trusts. With less competition, the lenders who are still active are able to charge higher rates and get better deal terms from borrowers.
Invesco Real Estate, which has a long track record of raising funds from institutional investors for real-estate credit funds, is raising its first such fund targeting the retail audience.
Many of the new funds, such as those being raised by Invesco and Cohen & Steers, are targeting individual investors. Smaller investors have shown an enormous appetite for property investments in recent years, especially with the growth of the nontraded real-estate investment trust industry which raised about $100 billion in the past seven years.
But many of the non traded REITs that were formed before last year’s rise in interest rates have been under pressure to redeem money back to investors who want to cash out. Over $9 billion was redeemed in the first six months of this year, according to Stanger, and many investors have been forced to wait to get their money because of the rush to the redemption door.
Still, the new funds will be facing a lot of competition from cash-rich funds aimed at institutions. Opportunistic real-estate funds run by private-equity firms have nearly $145 billion in so-called dry powder for future investments, up from $120 billion at the end of last year, according to data firm Preqin.
It is still possible that distressed opportunities won’t arise if the U.S. economy has a soft landing, in which inflation is tamed by the Federal Reserve without tipping the economy into recession.
Sales volume will likely increase when debt markets stabilise and values become more clear. “Broadly speaking, people are waiting to see what the world looks like,” said Michael Stark, co-head of the PJT Park Hill Real Estate Group, a global advisory firm and placement agent. “They’re waiting for motivated sellers.”
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Competition to buy the world’s most exclusive stores is intense despite modest rent growth. Even Blackstone is ogling the market.
3 min
Don’t expect any fashion bargains on Rodeo Drive in Beverly Hills, or New York’s Fifth Avenue. And property on these famous luxury shopping streets looks as overpriced as the clothes.
While the average commercial building is worth 20% less than in 2022, the world’s most exclusive shops have barely been touched by the highest U.S. and European interest rates in two decades.
Cartier’s Swiss owner, Compagnie Financière Richemont , recently bought a property on London’s Bond Street at a rock-bottom 2.2% rent yield. Similar to the way bonds work, the lower the rent yield, the richer the price paid. The Bank of England’s base rate is around double this level. Most investors these days wouldn’t buy real estate that generates less income than the cost of debt that might be used to purchase it.
Last month, Blackstone sold a luxury store on Milan’s Via Montenapoleone to Gucci owner Kering for a similarly eye-catching price. The building was part of a portfolio of 14 properties that Blackstone bought in 2021 for 1.1 billion euros, equivalent to roughly $1.2 billion. Kering coughed up €1.3 billion, or about $1.4 billion, for the Via Montenapoleone building alone, equivalent to a 2.5% rent yield.
The private-equity firm is understandably eager to do more deals like this, and has since bought another luxury store in London. It is a surprising focus for Blackstone, which for years steered clear of retail property.
Luxury rents are resilient, but they aren’t rising fast enough to justify such hefty price tags for the buildings. Last year, rents increased 3% on Rodeo Drive and were flat on Upper Fifth Avenue, according to data from Cushman & Wakefield .
What luxury retail properties do offer is scarcity. London’s Bond Street has 150 individual buildings, according to real-estate consulting firm CBRE . But because luxury brands are fussy about where they will open a flagship store, only around two-thirds of the street is considered posh enough, limiting their options.
Supply is even tighter on New York’s Fifth Avenue, where just four or five blocks of the six-mile avenue are ritzy enough to lure the world’s most expensive brands. The luxury shopping district of Rodeo Drive in Los Angeles has fewer than 50 individual buildings.
This creates intense competition for both space and ownership. The world’s biggest luxury company, LVMH , has more than 70 brands that need a foothold on prominent shopping streets. Increasingly, LVMH’s answer is to buy the best locations. The Paris-listed company owns at least six properties on Rodeo Drive and six on London’s Bond Street.
Luxury brands see their flagship stores as marketing tools. Counterintuitively, e-commerce has made its physical locations more important. Labels including Christian Dior have opened restaurants and mini museums in their boutiques to give shoppers an experience they can’t find online.
When they are investing this much money in refurbishments, it makes more sense to own than to rent . Luxury brands have spent more than $9 billion buying boutiques since the start of 2023, according to a Bernstein analysis, and they control increasingly larger tracts of major shopping districts. Back in 2009, brands owned 15% of the buildings on London’s Bond Street, says Phil Cann, an executive director at CBRE. Today, their share has jumped to 30%.
Luxury labels also need to avoid being kicked out of a property by a rival-turned-landlord, which is happening more often. British handbag maker Asprey was given its marching orders by Hermès on London’s Bond Street. The French brand bought the building that Asprey occupied since the 1840s and wants to convert it into an Hermès flagship. Rolex recently bought a store that is rented out to Patek Philippe, although its competitor doesn’t need to move out any time soon as there are still several years left on the lease.
Most luxury stores are still in the hands of sovereign-wealth funds or rich families who might have owned the buildings for decades. Given the enticing prices that brands are willing to pay despite high interest rates, more are considering cashing out.
Landlords from Hong Kong, who began parking their cash in luxury stores around 2010, are among those selling up. New York real-estate investor Wharton Properties also sold two Fifth Avenue buildings to Kering and Prada this year at very high prices that were equivalent to 2% rent yields. Wharton is experiencing some distress in other parts of its portfolio, so it might have needed to raise funds.
Luxury brands made huge amounts of money during the pandemic. Richemont currently has more than €7 billion of net cash sitting on its balance sheet. Merger and acquisition activity has been quiet, so real estate might be the next-best thing to pour their riches into.
Property deals on the world’s most expensive streets will continue to operate in their own twilight zone, no matter what central bankers do next.
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