Equity Trends in 2012
- Dec 23, 2011
The most recent downturn has given equity a new role. Where once lenders were satisfied with as much as 75 percent debt, and in some instances even 80 percent (in previous years, even more), this much-more-chastened market has made it increasingly challenging to fill the gaps in the capital stack.
Equity providers, however, are not eager to market themselves. In fact, responses to our latest survey of equity providers found many leading players hesitant to disclose too much information about their proprietary tactics. Under those circumstances, rather than publish a list of the companies and their overall volume, we decided it would be more beneficial to provide insights derived from survey results and discussions with respondents that illustrate where equity offerings are trending.
The firms that responded to this survey represent a significant portion of the industry. Together, they provided $11.8 billion through investment partnerships during the time period including fiscal year 2010 and the first two quarters of 2011. That value was dominated by joint venture investments, with small portions of preferred equity and limited partnership moves dotting the landscape. While the respondents to the direct lenders survey discussed in the November 2010 issue were generally optimistic about the market improving for 2012, two-thirds of the equity providers surveyed believe investment activity will neither increase nor decrease over the next two quarters.
As one might expect in this market, the majority of equity (about 54 percent in this case) has been used for acquisition activity. Properties continue to change hands, and investors are still hunting down assets in core markets while the price is right. That being said, equity for development activity comprised a large chunk, at 27 percent of the total provisions. While new developments are only trickling in due to the sluggish economy and limited access to capital, certain regions and property sectors are hotter than the rest. More than 37 percent of equity provided for development, for instance, was for assets in the Eastern states. Western states came in a close second with 32 percent. The South saw a hair over 20 percent, while the Midwest received just under 10 percent of the pie.
Among property types, multifamily received more than 43 percent of the equity disclosed by respondents. This was not surprising considering the demand from shifting renter demographics and the lagging single-family recovery. Partnering up has proven a successful approach for landing the large properties in the core areas with high rents and low vacancies.
The equity questionnaire also asked for a breakdown of active funds. Core, value-add and opportunistic strategies were equally represented. A lack of funds geared toward distressed assets suggests that investors believe the sector has been dug through. The average return requirements varied a few percentage points by category, with a median return requirement between 15 percent and 17.5 percent.
As of press time, Congress is still unable to arrive at a consensus that will provide any kind of meaningful debt reduction. Commercial real estate remains very sensitive to the overall economy, and when markets decline (stock, bond and commodity), the sector gets an almost-immediate boost before succumbing to the decline in market prices.
We believe that after remaining stable for the balance of 2011, equity volume will begin to rise in 2012 as both inflation and economic uncertainty take hold. We do not believe there will be huge gains in rates, but instead terms for equity will tighten even more. Underwriting will have to recognize more realistic preferred returns, changes in fund structures and different ways to assess carried interest between partners.