By Steve Williams on May 9th, 2017
We write periodically about measuring “dry powder” as an indicator of future deal volumes. Several fund managers have recently mentioned it to me again. The world’s real estate capital dam, they suggest, is nearing its high watermark. So, given this growing wall of unallocated capital, why are our current YOY deal volumes trending downwards?
There is a dual answer. First, brimming reservoirs of pent-up capital are pinned back behind a wall of geopolitical uncertainty. Uncertainty plays into the hands of opportunists but gives traditional property funds the jitters. Second, the slowdown in overall activity has not triggered any widespread softening of prices. Sellers are content to hold what they have.
A bigger problem of course is the collective reluctance of funds to move away from core markets. “Core is king” is a theme we frequently return to. In February in our US Capital Trends report we looked at shifts in risk-taking in 2016 and found some appetite for secondary market risk but less desire for investment style risk.
The allure of a relatively small yield increment, we discovered, was not enough to shake a natural instinct to preserve capital. Believe it or not, the pain of post-GFC losses still keeps some major funding sources locked down in core markets.
Despite this continuing intransigence, we continue to watch the data for any early indications of capital moving into non-core sectors. This is where the theory of “spillway capital” is useful. Spotting a trickle of capital running down the spillway (the dam’s runoff channel) into non-core sectors may be an early sign. We ignore the trickle at our peril. Dismissing it merely as sporadic outlier activity, puts us in danger of missing clear warnings that a more significant flow of non-core capital is about to breach the main dam.
We are eyeing four U.S. non-core sectors – student accommodation, retirement living, self storage, and medical office – for the early signs.
Within our total deal volume data, these represent small “spillway” increments. Mindful of capital’s well proven herd instinct, at what point does a “spillway trickle” become a steady flow of capital powering the turbines of a measurable trend?