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How Lower Interest Rates Shape Private Equity and Real Estate Investment Strategies

In the ever-changing financial markets, interest rates play a pivotal role in shaping the strategies of investors across the board. The Federal Reserve's hints at rate cuts throughout 2024 have created substantial anticipation, triggering a ripple effect across the private equity markets and commercial real estate sector. Let's delve into some of these effects and explore the dynamics at play.

Enhanced Capital Availability:

Lower interest rates have historically led to enhanced capital availability, fundamentally altering the financial landscape for private equity funds and real estate investors. A notable example is the aftermath of the 2008 financial crisis when the Federal Reserve implemented decisive rate cuts. The resulting surge in liquidity not only stabilized the markets but also stimulated diverse investment opportunities across sectors including the private markets and commercial real estate.

As investors look forward to the potential rate cuts in 2024, historical instances serve as a lens through which we can anticipate increased liquidity for private equity funds and real estate investors. Lower rates should result in cheaper borrowing for buyers across the board, and cheaper borrowing means better access to acquisition financing. These factors, in turn, lead to greater real estate investment activity, and at lower cap rates and typically higher valuations. Cheaper financing and better availability of capital should also result in enhanced dealmaking across the private equity sector. Edwin Conway, Global Head of Private Markets at BlackRock, remarked “We expect private markets will remain an attractive option for investors to deploy capital in 2024 and beyond. While the macroeconomic volatility we saw this past year resulted in more capital left on the sidelines, we expect new higher-quality opportunities with favorable deal structures to emerge for investors across asset classes in the year ahead.“

Private equity firms will reap other benefits from lower interest rates as capital sources open up, spurring acquisition activity. Additionally, low rates facilitate easier exits from investments as buyers find it more feasible to finance acquisitions or IPOs. Anthony Diamandakis, who runs Citi's global asset manager advisory business remarked “We will also probably see some more exits from portfolio companies, more deal activity in 2024 to show good returns to the LPs.”

This combination of factors should spur M&A volumes globally. Additionally, lower rates should stimulate consumer spending and demand for products and services, while also intensifying market competition. The increase in investor competition due to cheaper availability of capital should also raise the question of how private equity firms can differentiate and stay competitive in this new market dynamic.

Evolving Investment Strategies:

Historical trends reveal the adaptability of investors in response to fluctuating interest rates. In the context of potential rate cuts in 2024, we expect buy-side investors to reassess and adapt their strategies. The evolving investment landscape may witness a shift towards alternative investments, such as private equity, real assets, and innovative financial instruments. Understanding these historical

patterns provides insights into potential strategic adjustments in response to changing interest rate dynamics. Our team predicts this shift in the following ways:

  • Private equity firms and real estate investors should be more active this year as borrowing gets cheaper across the board

  • Cap rates should hopefully follow interest rates downwards, helping buoy real estate valuations and furthering the positive arbitrage between cap rate multiples and EBITDA multiples for sponsors

  • Cheaper borrowing and better access to acquisition financing should lead to increased M&A activity and overall deal flow

  • Greater M&A activity and increased sale leaseback arbitrage benefits should spur sale leaseback volumes in the middle-market

Last year’s high rates and volatility led to relatively low M&A activity, leaving private equity firms on the sidelines with a record $2.3 trillion of dry powder ready to deploy, according to Prequin. This also led to a decline in sale leaseback volumes to the tune of around 45%. This should all come to the forefront with pent up dealmaking demand coming to the forefront in 2024. As deal activity increases, this should have positive effects across the board for other asset classes such as private credit and lending, and commercial real estate, especially sale leasebacks that serve as acquisition financing to private equity backed transactions.

Are Real Estate (and Sale Leaseback) Strategies on Your Radar?

Commercial real estate, a sector critically influenced by fluctuating interest rates, presents unique challenges and opportunities for investors. Amidst declining rates, the real estate market becomes a focal point for strategic investment decisions, as cap rates tend to follow decreases in borrowing costs that lead to potentially higher property valuations. One such opportunity is the sale leaseback transaction – our specialty here at Ascension Advisory.

The sale leaseback strategy, an intricate financial maneuver, involves selling a property and then leasing it back from the new owner. This approach unlocks the intrinsic value of real estate assets, particularly powerful in a lower-interest-rate environment. As rates decrease, the benefits of sale leaseback transactions are further amplified as cap rates are expected to follow interest rate trends. Investors and sellers are expected to increasingly explore this avenue as we move through the new year.

Exploring the benefits of sale leaseback transactions in previous articles provides valuable insights into how this strategy can optimize portfolios and navigate the dynamics posed by shifting interest rates. As rates trend downwards, understanding the nuances of sale leaseback transactions becomes even more critical for investors looking to capitalize on the evolving market dynamics. Benefits of the sale leaseback amidst shifting interest rates include:

  • Unlocking Liquidity: By selling the property and leasing it back under a long term, absolute-net structure, the seller can free up capital for immediate use.

  • Fixed Cost Structure Amidst Market Volatility: By entering into long-term lease agreements, lessees establish predictable costs, shielding themselves from the uncertainties of market fluctuations.

  • Mitigating Risk and Improving Balance Sheets: By converting owned assets into leased assets, companies reduce exposure to market valuation risks.

Further Reading:

Lower interest rates not only influence capital availability and drive evolving strategies but also inspire innovative real estate investment and financing tactics globally. For a deeper exploration of these dynamics on a global scale, we recommend digging into another insightful article in this month's Ascension journal. Chelsea and Nina explore the potential impacts of lowering interest rates on sale and leaseback transactions throughout Europe, providing a comprehensive perspective on the nuances and opportunities we expect in 2024 throughout the region.


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