CRE Valuation Uncertainty Threatens Private Equity Real Estate Model

Falling commercial real estate (CRE) valuations have been a persistent challenge, impacting refinancing and mortgage covenants. Jim Costello of MSCI Research highlighted that the uncertainty around asset valuations and limited partners’ ability to access capital are risks to the U.S. private equity real estate model, especially with gated withdrawals at some open-end CRE funds.

During the pandemic, ultra-low interest rates and increased liquidity led to a surge in CRE investments, driving up prices. However, rising inflation and higher interest rates later caused valuations to drop, affecting private equity firms. Despite using advanced models, there were significant variations in asset value assessments, creating opacity in the market.

MSCI data showed that the U.S. had the worst performance globally, with a -6.8% difference between appraised values and sale prices. This situation echoed past concerns about inflated valuations in the 1990s at Prudential Insurance. While no misconduct was implied, Costello noted that during falling valuations, managers might be incentivized to delay revealing asset value drops.

Further data showed central business district office appraisals had fallen 43%, while transaction prices dropped 51%, suggesting the need for more transparency through third-party validation methods for limited partners.

 

Source:  GlobeSt.