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The boom in private-equity real estate fundraising that has delivered a slew of billion-dollar megafunds in recent years has slammed into some formidable headwinds. Yet near-term challenges are not diminishing the appetite for capital among a still-crowded field of fund managers and sponsors.

Silverstein Capital Partners is among the latest to announce a new fund that aims to raise $1.5 billion to fund conversions of distressed office towers in New York and other major cities into housing. The latest fund comes on the heels of Silverstein’s successful close on a $2 billion opportunistic fund a year ago that focuses on providing a variety of loans and rescue capital to borrowers in North America.

And Silverstein is not alone. According to Preqin, there are roughly 1,100 close-ended real estate funds with a regional focus in North America that are currently fundraising, the majority of which—more than 700—operating on value-add or opportunistic strategies. Although many fund managers and sponsors are not tapping the brakes on capital raising, they do face challenges in capturing fresh capital as investors pull back.

Source: Robert A. Stanger & Company

The robust pace of fundraising seen in the first half of 2022 slowed significantly in fourth quarter for a number of reasons, chief among them being rising interest rates and market uncertainty. “The ability to transact in real estate has become more challenging, and I think investors recognize that and are saying, ‘let’s let that settle out,’” says Kevin Gannon, chairman and CEO of Robert A. Stanger & Company, a real estate investment banking and advisory firm. That is always the case when there is that type of interest rate movement. “So, fundamentally, we’re hitting timing right now where buyers and sellers are not quite lining up, and that is reflected in the fundraising.”

Fundraising Momentum Slows

Industry data continues to show a solid year of fundraising in 2022. According to Preqin, private equity funds targeting North America have raised $110.4 billion year-to-date through early December. Although that is lower than the post-pandemic surge to $141.7 billion raised in 2021, levels are comparable to 2019 inflows that reached $118.0 billion.

Data from Robert A. Stanger also reflects a healthy year of fundraising in real estate alternative structures with $98.7 billion in year-to-date fundraising through October that is up 38 percent over the same period in 2021 across structures including non-traded REITs, interval funds, Delaware Statutory Trusts and non-traded BDCs. “The full year looks good, but it’s come down dramatically from where we started the year, and we think the first half of 2023 is going to reflect that,” says Gannon. For example, non-traded REITs raised about $30 billion in the first 10 months of 2022 at a pace of roughly $2.5-3+ billion per month. For November and December, activity had slowed to about $1.1 billion, according to Stanger.

“In real estate fundraising, we have seen a very substantial slowdown in the last two quarters,” agrees Douglas Weill, managing partner at Hodes Weill & Associates. “There are still funds that are having closings. Many of those are long-standing, well-established firms that are raising a follow-on fund.” However, many institutions have deferred investment decisions until 2023. In particular, there is meaningful slowdown in allocations to closed-end private equity real estate funds, while open-end funds are facing challenges related to a growing queue of redemption requests from investors, especially related to core and core-plus strategies, adds Weill.

Rise in Redemption Requests

Another hurdle for fund managers looking to raise capital is a surge in redemption requests from investors. However, inflows and outflows are rarely linear. “There are going to be peaks and valleys, and right now we’re going through a very choppy macro environment,” says Tim Bodner, real estate deals leader, PwC US. Issues such as rising interest rates, geopolitical events and mixed views on whether the U.S. will move into a recession or not is contributing to uncertainty. “Naturally, when you have all of those things going on, you will have a subset of investors who choose to take some liquidity off the table,” he adds.

Although a surge in redemption requests is not necessarily welcome for private real estate funds that, by nature, are illiquid, it is not necessarily a cause for panic. For example, the new generation of non-traded NAV REITs are designed with an element of liquidity built in to fulfill redemption requests. Redemption requests are bracketed up to 2 percent of outstanding per month and up to 5 percent per quarter. To accomplish that, non-traded REITs are built with liquidity sleeves and capital that is invested in more liquid securities that they can tap into, so they aren’t forced to sell property in a down market to raise capital.

“Some will hit the 5 percent cap, but many of them haven’t,” adds Gannon. “The point is that they are meeting liquidity requests up to the liquidity cap, and I think investors will ease off of requests once they realize that liquidity is there even if they have to wait a little bit, because it is real estate and not instantly liquid.”

Capital Eyes Market Dislocation

It is difficult to paint the entire private equity sector with the same brush, and a deeper dive shows a mixed appetite for capital depending on the sponsor and strategy. Many of the largest private equity fund managers and sponsors have raised significant capital over the past 12 to 18 months, and deploying that capital effectively remains a top priority. Preqin estimates that private equity real estate funds with a focus on North America have an estimated $240.4 billion in dry powder at the end of December.

“We are hearing from managers that they’re moving very slowly in terms of capital deployment and sitting on a considerable amount of dry powder,” says Weill. “So, from a fundraising standpoint they’re not expecting to be back in the market in the near term. But, when the market does reset, and if transaction volumes surge in the face of distress, you may see these managers become very acquisitive and deploy money in a rapid way and then come back to market sooner than expected.”

“Capital deployment in a choppy environment is an area of focus, but investors are still looking at raising their next fund,” adds Bodner. Once retail channels get up and running, it tends to be a somewhat continuous spigot for capital raising. So, open-end and non-traded REITs are by no means pumping the brakes on capital raising efforts. In addition, some of the large closed-end funds raised over the past 12-18 months have already committed capital and are looking to go back out to the market in early 2023. “So, it would not be surprising to us to see some offerings on the road in early 2023 on the close-ended side,” he says.

The recent slowdown in private equity fundraising is likely a “digestion period” as the market adapts to market changes and waits for more stability and clarity on Fed policy. Stanger expects non-traded REITs to raise capital at its current pace of roughly $1+ billion per month or $10-12 billion annually, at least for the first half of the year, and then rise from there as the Fed eases off of its aggressive rate increases.

Some fund managers and sponsors will be better positioned to attract inflows then others. Capital tends to flow to opportunistic strategies during times of market dislocation, and investors want to invest with those sponsors who have a proven track record for deploying capital. Multifamily and industrial are still hot, although not as hot as they were a year ago. In addition, there also is more focus on alternative sectors, such as life sciences, data storage, self-storage and single-family rental housing.

“The U.S. real estate market is going into a part of the cycle that is more opportunistic in nature than where we have been. So, the opportunistic pools of capital will be more active than the core and core-plus pools of capital,” adds Bodner. Those opportunistic strategies will focus on both equity and debt investments. A lot of capital has been raised by private equity funds with credit strategies that want to provide debt that hasn’t been fully put to work. “So, we expect to see most activity on the opportunistic side, but with a mix between debt and equity,” he adds.