For private value-add and opportunistic real estate funds in the years following the Global Financial Crisis, there is a strong inverse correlation between capital scarcity, reflected in the smaller average fund sizes in years when markets were volatile, and outperformance. One of the best-performing average vintages for European value-add and opportunistic real estate funds was 2009, when real estate markets were still very turbulent and average fund sizes were relatively small at less than $500 million. On the other side of the spectrum, the smooth years of steady growth in 2017-2019 produced relatively big funds with relatively lackluster results. We think the characteristics of the 2024-2025 vintage are more in line with that of 2009 than that of 2017. Fortune has historically favored the brave early movers.
What Does the Recovery Look Like So Far?
Financing is recovering in Europe, with banks lending more aggressively ahead of potential further interest rate cuts and non-bank lenders providing alternative sources of credit. Non-bank lenders comprise approximately 40% of the real estate credit market, up from 14% a decade ago.
For the coming period, we think equity investors with scaled capital to deploy are at an advantage due to the lack of competition in the market. While investors have tended to view tighter financing conditions as a signal that the market remains too risky, we think it is instead an opportunity to take advantage of buying opportunities while market competition remains muted.
Continuing a trend we described in our May 2024 market outlook, many real estate owners are facing some degree of liquidity pressure that creates a need to sell assets. For some, the pressure comes from capital structures that worked in a low-rate, low-inflation environment but are no longer suitable after a repricing and a rise in interest rates. In other cases, real estate funds are reaching the end of their lives and must begin selling property to return capital to investors. For open-ended core funds, many of which are overexposed to office and retail, a steady drumbeat of redemption pressure is driving property sales. These funds typically sell their most liquid assets first, which tend to be in popular sectors with strong demand tailwinds, including logistics, residential, and student housing. When these funds are ready to start buying again, they will look to rebalance through buying property in the same sectors they are now selling. We think it is very possible that scaled players with access to capital will end up both buying assets from this group now and selling to them later.
What Will Drive the Recovery Going Forward?
We expect the tight supply and strong long-term demand trends in our preferred sectors (logistics, multifamily, student accommodation, and hospitality), rate moderation, and stronger capital flows into private real estate to drive returns going forward.
This downturn has also sharpened a bifurcation between prime and secondary properties, as well as the importance of understanding local dynamics.
KKR’s dedicated local operating platforms that specialize in areas such as pan-European logistics, U.K. hotels, U.K. residential, German residential, and Irish residential lending provide on-the-ground resources and sector expertise to source properties in our preferred sectors and implement value creation plans.
Conclusion
In our preferred European real estate markets and sectors, we see a compelling, time-sensitive investment opportunity, owing to reset valuations and strong supply-demand dynamics. Motivated sellers and a lack of market competition is enabling those with dry powder to acquire high-quality assets with the potential for strong risk-adjusted returns. However, we are also seeing market activity and sentiment pick up as lending markets re-open. Once the feeling is widespread that real estate markets are back and “safe” to invest in again, we suspect it will already be too late to take advantage of this market dislocation.
