The year 2023 has presented new challenges for private market fundraising after a period of steady growth during the post-financial crisis expansion and accelerated growth during the pandemic. Despite the current pace suggesting over USD 1 trillion will be raised this year, investors are expressing concerns about the ability of private market investors to capitalize on various trends within the asset class in the future. Although there is an abundance of dry powder (For venture capital (VC) and private equity (PE) firms, dry powder refers to the amount of committed, but unallocated capital a firm has on hand. In other words, it’s an unspent cash reserve that’s waiting to be invested. As a highly liquid asset, investors and corporations use dry powder strategically to gain financial success or ease financial stress.), such as private equity sitting on more than USD 1 trillion, the question remains: What are the viable opportunities that lie ahead?
The Outlook for Private Real Estate
The landscape for private real estate is a mix of favorable and challenging factors. While overall capitalization rates are moderating, real estate appears expensive due to slowing net operating income growth, elevated prices, and higher interest rates. Transaction volumes have also declined over the last four quarters, primarily driven by increased rates and stubborn inflation. However, a closer look at the sector reveals differences in fundamentals. The office sector continues to face challenges, with high vacancy rates and companies struggling to transition away from remote working. Retail, on the other hand, is experiencing a gradual softening as consumers deplete excess savings, leading to lower but still elevated vacancy rates. The residential segment also presents a varied outlook, with low housing inventories potentially limiting downside risks to home prices in certain regions, but the strength in multi-family housing starts could restrict rental upside. Conversely, the industrial sector remains robust in the commercial real estate space, with historically low vacancy rates supporting rents and prices in the short term, despite a slowdown in construction and groundbreaking activity.
Navigating Challenges for Private Equity
For private equity investors, the macroeconomic backdrop has become more demanding. Heightened recession risk and higher debt financing costs pose as headwinds, though better-than-expected earnings and moderating interest rate expectations in the first quarter of 2023 resulted in a modest increase in valuations. While deal activity remains above pre-pandemic levels, it has dipped from the highs observed during the pandemic era. In the current environment, private equity investors are showing a preference for add-on deals.
The Resilience of Private Credit
Private credit continues to experience strong demand as public market financing sources shrink due to stricter lending standards. Notably, private credit exhibits higher exposure to information technology and financials, whereas the leveraged loan market has a relatively higher concentration in industrials, consumer discretionary, communication services, and materials. In the first quarter of 2023, private credit transactions constituted 72 out of 76 leveraged buyout financing deals, even though private credit transactions typically come with spreads approximately 300 basis points wider than public market pricing. This spread is expected to further widen in the upcoming quarters.
Conclusion
As 2023 unfolds, private market fundraising faces complexities, with both opportunities and challenges across various sectors. Private real estate experiences mixed fundamentals, while private equity navigates macroeconomic headwinds with cautious optimism. In contrast, private credit remains robust, capitalizing on its resilience amidst changing market dynamics. To seize the potential opportunities, investors must adopt a well-informed and nuanced approach to make the most of the prevailing conditions and position themselves for success in the evolving landscape of private markets.
