Investment Flow and the Rise of Private Capital

Happy Monday and welcome to the latest edition of the Riopel Real Estate Roundup! I am excited to share with you the latest trends and insights in the industry. The commercial real estate market is incredibly complex and complicated, today there's an interesting dynamic occurring. How the market behaves is often reflective of the primary players. There's a shift occurring moving from an institutionally dominated market, to one that is more dependent on private investors. So today's topic is a deeper look at commercial real estate investment with a focus on who is investing capital and where.

As I mentioned, there is a growing trend towards private capital filtering into the commercial real estate market, last week a report was published that confirmed private investment has overtaken institutional capital in the market for the first time ever. Private investors likely think about the market and act much differently than most institutions, which could have a dramatic effect on how investments are made in commercial real estate now and into the future.

But before we dig in, as always, if you're interested past editions of the Riopel Real Estate Roundup can be found here for those interested.

Knight Frank's "The Wealth Report"

Last week Knight Frank released its annual "The Wealth Report", and it's a treasure trove of interesting market insights and a deep dive into where capital flows are coming from at a particularly interesting time when a lot of capital has seemed to have dried up or is sitting on the side lines. From the report, one of the big takeaways (and the one we will dig a little deeper into in this article) is the revelation that private investors for the first time overtook institutions in commercial real estate investment in 2022. That's big news for commercial real estate as traditionally institutions have been market drivers setting expectations and oftentimes act as the 10,000 pound guerrilla dictating what's deemed to be reasonable, so a shift towards private investors and if that source of capital continues to be dominant, it may dramatically shift how transactions are done and shift what's typically been seen historically as "market" terms. First, let's dig into the numbers...

Private Investors Overtake Traditional Institutions for the First Time

According to a recent report from RCA ( MSCI Inc. ), private investors were the most active buyers in global commercial real estate markets in 2022, investing a staggering US$455 billion, representing 41% of the total investment. This is the highest share of global commercial real estate investment on record and the first time private investment has surpassed institutional investment. While private investment was down from its all-time high in 2021, 2022 was still the second strongest year in history, sitting 62% above the 10-year average.

The fact that private investors have overtaken institutions in commercial real estate investment is significant for a number of reasons.

Historically, institutional investors such as pension funds, insurance companies, and real estate investment trusts (REITs) have been the dominant players in the commercial real estate market. However, the trend towards greater private investment reflects a shift in the way that capital is being deployed in the sector.

First, it indicates that private investors are becoming more involved in commercial real estate markets, which can lead to increased competition and more diverse sources of capital for real estate projects. Private investors can focus on niche markets or particular asset types, whereas institutional investors may need to take a more diversified approach to portfolio management. This can result in more innovation in the industry, as private investors may bring fresh ideas and approaches to investing and developing real estate assets vs. the traditionally stodgy approach of many institutional capital providers.

Second, private investors may be more nimble and flexible in their investment decisions than institutions, who often are highly regulated and have more rigid investment criteria and processes. Private investors are often able to move more quickly than institutional investors, who may be bound by a more bureaucratic decision-making process. This can be particularly important in a market where conditions can change rapidly, and where opportunities can arise and disappear quickly. Private investors may be able to act more quickly and take advantage of opportunities that institutions may overlook or be unable to pursue.

Third, the fact that private investors are investing more in commercial real estate than institutions suggests that they have confidence in the asset class and see it as a viable investment opportunity. At the same time, the trend towards greater private investment in commercial real estate also reflects broader changes in the investment landscape. The rise of high-net-worth individuals and family offices has led to a proliferation of private investment vehicles, including private equity funds and joint ventures. This has enabled private investors to access institutional-quality assets and compete on a more level playing field with larger institutional investors. This could have positive implications for the industry as a whole, as increased private investment may encourage other investors to take a closer look at commercial real estate and consider investing in it.

Finally, the shift towards greater private investment may lead to changes in the way commercial real estate is managed and operated. Private investors may bring different perspectives on what constitutes a successful real estate asset, which could lead to new approaches to leasing, tenant engagement, and property management. This, in turn, could result in a more dynamic and innovative real estate industry overall. Overall, the fact that private investors have overtaken institutions in commercial real estate investment is a sign of the increasing importance of private capital in the sector. While institutional investors will continue to play a key role in the market, the rise of private investment reflects a growing recognition of the benefits of agility, flexibility, and tailored investment strategies in a rapidly changing market.

Where Private Capital is Flowing

Multifamily residential, offices, and industrial assets were the most attractive sectors for investment, as reflected in the The Wealth Report Attitudes Survey, with ownership in retail, life sciences, healthcare, data centers, and education real estate increasing in 2022 compared to the previous year.

Geographically, the US, UK, Germany, Canada, and France were the top destinations for private capital last year. However, of the top 10 destinations, the UK and France were the only countries to see year-on-year increases in total private investment. US cities remained a target for private buyers in 2022, with US metropolises accounting for 67% of the total volume. London was top for cross-border private capital, accounting for 44% of the total private investment into the city and 15% of total global cross-border private investment into cities in 2022. Private investors from the US were the largest source of capital last year, with more than a quarter of total commercial real estate investment and 66% of private investment. However, investment from US private buyers was down 3% year-on-year. Of the top 10 sources of private capital last year, investors from France and the Chinese mainland were the only buyers to increase investment in 2022, up 27% and 25% on the previous year, respectively.

The Inflation Effect

The overriding theme from The Wealth Report was that inflation is a significant factor that is currently driving investment decisions in commercial real estate, with many investors looking for stable and predictable returns in assets that have indexation to inflation. This is particularly relevant in the current environment of higher inflationary pressures, where investors are looking for ways to mitigate the impact of rising prices on their investments.

According to a recent HNW (high-net-worth) Pulse Survey by RCA ( MSCI Inc. ), 80% of respondents stated that inflation would influence their investment decisions in 2023 either significantly (37%) or to some extent (43%). This indicates that investors are acutely aware of the impact of inflation on their portfolios and are looking for ways to manage this risk.

Commercial real estate is an asset class that has traditionally provided investors with inflation-hedging benefits due to its ability to generate income from rental payments, which can be adjusted to keep pace with inflation. This means that as inflation rises, so too does the income generated by the asset, leading to greater returns for investors.

In addition, commercial real estate can provide investors with a source of capital appreciation as property values increase over time. This growth potential can be particularly attractive in assets with indexation, as the asset's value will be adjusted to reflect changes in inflation.

As a result, despite the challenges from the Fed in raising interest rates, many investors may turn to commercial real estate as a way to navigate the higher inflationary environment. This is reflected in the recent trend of private investors overtaking institutions in commercial real estate investment, with private buyers accounting for 41% of total investment in 2022, the highest on record.

Moreover, this trend towards private investment is likely to continue in the future, as investors seek out stable and predictable returns in assets that can provide protection against inflationary pressures. As the global economy continues to grapple with the ongoing effects of the pandemic and geopolitical uncertainties, commercial real estate is likely to remain an attractive investment option for those seeking to manage risk and generate long-term returns. To navigate the higher inflationary environment, investors may pivot towards commercial real estate due to its strong growth potential, particularly in assets with indexation.

In conclusion, the rise of private investors in commercial real estate investment is a notable trend, and it will be interesting to see how it develops in the coming years. I will continue to keep you updated on the latest news and insights in the industry. Thanks for reading, and I’ll see you in the next edition of the Riopel Real Estate Roundup.