Ackman-Ziff 2024 YE Market Update

As the year comes to a close, I’m filled with gratitude for the partnerships, successes, and milestones we’ve shared in 2024. Thank you for being a part of our journey!

I hope you have a safe and joyful holiday season surrounded by family and friends. We’re excited about the opportunities that lie ahead and look forward to building more success together in 2025!

DEBT: Real estate credit strategies to remain in focus among elevated interest rates environment

• Since 2020, $137.2 billion has been raised for debt strategies across more than 430 closed-end funds. This accounts for around 16% of CRE fundraising, a sign of investment managers’ and investors’ expanding view of real estate opportunities.

• A significant amount of investment managers and investors are looking to credit strategies as a growth driver for capital deployment, and to grow their AUM.

• Given the declines in real estate values since the market peak in early 2022, there will be many situations where new equity is required to keep LTV ratios steady and continue to meet debt service covenants. The greatest risk relates to assets financed from 2019 to 2021 at peak valuations. The refinancing shortfall, meaning the amount of new equity required for these loan maturities, ranges from an estimated $270 to $570 billion, based on the range of value declines at the maturity date.

• In terms of new capital, expect private credit to continue dominating. Private credit can span multiple strategies, such as direct lending, mezzanine or preferred equity, and distressed debt.

• The next several years are expected to offer an attractive environment for private real estate credit, where investors stand to benefit from opportunities where financing options from banks and other traditional lender types are more constrained.

EQUITY: Funds of scale and with higher-yielding strategies will have the advantage

• As confidence in real estate markets has slowed down, so has capital raising for real estate funds. During the first half of 2024, $70 billion of real estate capital was raised globally in closed-end real estate funds, 25% below the first half average of the prior five years.

• At the same time, substantial liquidity remains on the side-lines. Dry powder for commercial real estate totaled $394 billion as of August 2024. The question for investors is how and where that pent-up demand will enter the market.

• Here are a handful of the biggest implications for the real estate cycle in the coming months:

  1) Higher-yielding strategies will deploy first - Real estate is entering a new normal of higher rates. Capital deployment will focus on strategies offering returns that are competitive against the higher cost of capital. This will trigger an increased focus on value-add and opportunistic strategies over core and core-plus in the near-term, while favoring strategies that provide opportunities for active asset management to enhance returns.

  2) First movers have the advantage - In markets where capital values appear to be bottoming out, higher return requirements will drive capital deployment sooner rather than later. This will be particularly evident for asset classes and geographies where rental growth forecasts can be underwritten with the greatest confidence. Capital value growth in the medium term is likely to be underestimated, and capital will crowd into strategies where income growth can be confidently underwritten.

  3) Interest rates will dictate the pace of dry powder deployment - The interest rate cycle has historically been led by the Fed, with other major central banks to follow. In anticipation of this, capital is already moving to US-focused strategies.

  4) Investors will look across the capital stack to debt and hybrid structures - Investors will not only emphasize higher-yielding equity strategies, but also on debt or hybrid structures such as mezzanine or preferred equity positions. The deployment of capital into debt strategies is nuanced across geographies.

  5) Activity will be concentrated around investors with more capital - Investors with larger pools of capital are better positioned to weather future risk and will benefit from their flexibility to deploy across regions and sectors, with allocations being determined by return opportunities. Conversely, investors with limited liquidity will find it hard to deploy capital and may be forced to accept lower yields in an increasingly competitive environment once the market recovers.

The outlook for Opportunity Zones is promising, especially in light of the recent election outcomes.

A New Administration and Its Impact – A second term for Trump, coupled with Republican control of Congress, is likely to lead to an extension and renewal of the Opportunity Zones program, which is currently set to expire in 2026. It remains to be seen how quickly Congress will act and what specific reforms will take shape.

Opportunity Zone 2.0 – If renewed, I’m hoping to see a restructuring of how the census tracts are designated and which tracts would qualify for the tax break along with an increase in transparency around the program.

Ackman-Ziff’s Recent Activity within OZ Capital Raising – Given how difficult sourcing common equity is for ground-up development, but the continued appetite for OZ funds to get capital out the door, we created a few unique structures that have aligned with the risk-adjusted returns for the OZ funds and helped sponsors capitalize developments in a way that helps reduce downside risk but still provides similar characteristics to that of a standard promote waterfall. We’ve had a lot of recent success in this space and happy to walk through the risk and mitigates of these structures.

Four major themes were widely discussed in our meetings at ICSC last week:

• Institutional Appetite for Retail – The Charlie Brown Football Gag of Retail Investing. For many months (even years) pension fund advisors have stated that their separate account clients and the managers of their co-mingled funds are underweight retail and ready to invest.  “No, really, this time we mean it.”  Yet most have yet to make their way from Conversation to Consensus, to Conviction, and finally to Capital Commitments, AKA acquisitions. Retail is a sector where one can always find a reason not to buy a property.  It remains to be seen whether this investor group can broaden their views to reflect market realities.  Most recently, I heard of a fund that was having trouble finding “core-plus, grocery-anchored centers in high-growth markets”. That category sounds like an oxymoron and might be a null set. The football gets pulled away again.

• Interest Rates – The Elusive ‘New Normal’. No one I spoke with expects that Treasury rates will drop below 3% in the foreseeable future.  Any reductions made to the Fed Funds Rate will have an immaterial impact on the longer-term bond market, which is the primary benchmark for pricing fixed-rate financings. The current cost of debt capital is, of course, much higher than pre-COVID, but it is still at a level that broadly allows positive leverage for retail. Even so, for borrowers looking to market-time their rate lock or to close a refinancing, it can be concerning that the 10-year treasury is still fluctuating in a band of +/- 10% from 4.0%, or 80 bps over the trailing six months.

• Insurance Costs – An Impending Storm of Unaffordable Protection from Impending Storms. This is a very big issue for commercial landlords and homeowners in Florida and Texas among other areas. The frequency and severity of damaging weather is causing a rapid rise in property insurance rates which complicates underwriting. Compared to multifamily and office buildings, strip shopping centers have a much greater ratio of Roof SF to GLA, making it one of the most expensive asset classes to insure. Some owners I met with spoke of recent annual policy cost increases of 100%-250%. Passing the increased expenses to tenants is just another way of raising their rent, but it suppresses NOI growth. One owner was told by its insurance carrier that it had to remove its Texas assets from its national blanket coverage because the premiums were not properly adjusted for the increased weather-related exposure.

• Inefficient Marketplace – An Imbalance of GLA Supply and Demand.

  The national retail vacancy rate is reportedly about 4%, which is a 15-year low. Basic economic theory suggests that Landlords have pricing leverage and can raise rents until rental revenue warrants building more retail GLA, which would then abate rental rate increases. However, this equation is out of balance because construction costs and interest rates for construction financing have risen faster than rents. Tenants cannot afford to pay higher base rents because of the increased CAM reimbursement costs (see insurance topic, above) and rising operating costs, particularly around security and theft prevention. Overall, this moderates the downside of retail investment. For example, Landlords were able to backfill Bed Bath & Beyond and Party City vacancies quickly because they had multiple tenants lined up to do so – often from stronger expanding retailers like Burlington, Ulta, and Five Below.

Wishing everyone a wonderful holiday season and a happy & healthy New Year.

Jordan Brustein

E: [email protected]

M: (516) 996-7722