Private equity managers have responded by restructuring their real estate investment strategies and capital stacks to realign with the risk appetites of investors. Real estate valuations are central to the process of performance measurement and will be critical to executing in a period of heightened uncertainty in pricing. When macroeconomic changes are happening at a rapid pace, monthly valuations are not uncommon to assist fund managers in gauging exit risks on current investment strategies. Secondary market premiums and discounts to a fund’s net asset value (NAV) can appear to challenge third-party valuations due to the perception of risk by investors. However, valuations of real estate assets based on current market conditions and lease assumptions at a point in time are one of the best ways to assist fund managers in providing investors with a reliable indicator of NAV.
The timing of valuations of real estate assets can differ for higher-risk opportunistic funds versus lower-risk funds with long or indefinite lives. For the former, investors expect to see a return on and a return of capital in 3-7 years as development, redevelopment, or property-level upgrades impact the prospective market rent of these assets. Similarly, debt funds and alternative financing strategies generally provide short-term capital solutions to the current lending environment. In these situations, valuations are typically required for annual reporting and are monitored to evaluate market risk, but the frequency and importance increase as exit dates approach.
On the other hand, holding core and core plus assets with stable cash flows has become attractive to help mitigate the current pricing risk. Open-end structures are an intriguing trend being used by fund managers to hold these core assets. While the conditions may be ideal for long-term vehicles as the real estate sectors evolve and 10-year treasury bond yields begin to lower, regular valuations (typically annual with quarterly updates) will be vital to provide a more accurate and necessary indicator of the fund manager’s progress and monitor redemption risk in an illiquid market. Additionally, since investor subscriptions and redemptions after the lock-out period are priced by market valuations, an independent third-party specialist is highly recommended to maintain investor confidence.
