Rate Hikes
So what’s everyone in RE PE going to do? Kevin Warsh is definitely going to hike rates to get inflation down. Real estate and private equity generally are already screwed but FFR is going up 50-100bps.
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Based on the most helpful WSO content, the anticipated rate hikes will significantly impact Real Estate Private Equity (RE PE). Here's what you need to know:
Cap Rate Expansion: As interest rates rise, cap rates are expected to increase. This is because the discount rate (r + g, where r is the cap rate and g is the growth rate) will rise with higher rates, while growth may decelerate. This dynamic will compress valuations and make it harder to find attractive risk-adjusted returns.
Cost of Borrowing: Higher Federal Funds Rates (FFR) mean increased borrowing costs. This will likely deter leveraged deals and reduce transaction volumes, especially in high-profile markets where cap rates are already low.
Capital Raising Challenges: RE PE funds are already struggling to raise capital due to broader market conditions. With rate hikes, institutional investors like pension funds and sovereign wealth funds may further reduce allocations to real estate, as they rebalance portfolios toward more liquid or less risky assets.
Shift in Investment Strategy: Investors will need to adjust their theses to align with the new environment. Opportunities may still exist, but they will likely be in less "sexy" real estate assets with higher cap rates (e.g., 10 CAP deals) or in markets undergoing significant changes.
Market Slowdown: Rising rates will slow the housing market, as higher mortgage rates reduce affordability and demand. This will likely lead to a cooling of rent growth and property appreciation, further pressuring returns.
Potential Distress: While some investors are hoping for distressed opportunities, history suggests that true "fire sales" are rare. However, if rent collections decline significantly or over-leveraged players face refinancing challenges, some distressed deals may emerge.
In summary, RE PE players will need to moderate leverage, focus on value-add opportunities, and carefully navigate the challenging environment created by rate hikes.
Sources: Why is everyone saying real estate is peaking right now?, https://www.wallstreetoasis.com/forum/investing/apples-big-day-amazons-big-split-the-daily-peel-6722?customgpt=1, HF Industry Dying?, Who is buying this stuff? Brokers and PE analyst/associates
The issue with hiking rates is that it doesn’t actually fix the global shortages that Donald Trumps war war will cause. It’s merely used as a tool to decrease demand. And even if
rate hikes did ease shortages is won’t offset the millions of barrels of oil that would be lost everyday.
Politics aside, most people would agree that a rate hike will reduce global demand to balance out the supply constraints from the war.
No they don't, the supply inflation that ongoing is due to inelastic demand for energy inputs, a 50-100bps hike isn't going to change that demand much. Sure you can trim oil and gas consumption at the margins but in order push demand down enough to ease a supply shock you literally have to trigger a recession (i.e. contract the real output of the economy).
Hopefully Trump dies soon. Not that chubby eyeliner boy is much better, but his daddy Peter Thiel won’t let him ruin the economy.
Look, setting aside a broader discussion of hikes, it's not great for a bond-proxy asset class for sure. Deals with a business plan of cap rate compression are screwed and have been for years.
However, it's important to remember that the effect on value of cap rate expansion is exponential, not linear, and we've been sliding down the steep part of the decay curve so far. The value decline from a 3% cap rate to a 4% cap rate is -25% but from a 6% to a 7% is only -14%. It's a small solace but those that bought recently or wrote down assets to real cap rates are at least slightly better positioned than those that didn't (cough cough ODCE). Moreover, for those judged on TWRs instead of IRR, like the institutions that allocate capital to REPE funds, writing down earlier means you took your medicine and have been yielding 5% instead of 4%. The earlier you do that the better the overall time-weighted return.
Now on the broader discussion of hikes, it's a blunt instrument but it's the main one they've got. As others have pointed out it doesn't fix supply-side inflation and you have to deeply cut the economy to find success. I'm also concerned in future decades about use of that tool, because it's easier to restrict growth that is naturally high and buoyed by globalization, population growth, and increasing public spending, but tougher to do without damaging an economy that doesn't have those tailwinds.
The differing impacts of cap rates changes aren't exponential. They are a convex relationship is what you mean to say.
Well since exponential functions also exhibit convexity, perhaps the maximally accurate description is a positive reciprocal but few casual observers have that mental image ready - let's just settle on "nonlinear decline of decreasing severity" and call it a day lol
Honestly at this point maybe we need some hikes to force seller capitulation
Our current inflation is demand side inflation and the Fed chairman is pretty clear that inflation is a choice. You can see it in PMI, blue collar wages, tech sector taking prices. Inflation is in corporate earnings. Rates 75-100bps too low.
It’s so over
It is.
For those coming of age in RE after 2021 - it never even began
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