As GlobeSt.com has previously reported, monetary strategy during the pandemic created ultra-low interest rates and enormous amounts of liquidity injected into financial systems with high leverage. The desire for return resulted in many investors pouring money into the CRE asset class, driving up prices. Rapidly growing inflation eventually called out high interest rates from the Fed. That tanked transactions and drove valuations down.
PE firms often have expansive latitude in how they handle their activities and, as Costello pointed out, every PE fund manager saw negative impacts on asset values that started in 2022. It created an opacity in the real estate fund realm, similar to how a lack of price discovery was disruptive in CRE markets. Costello mentioned that many MSCI clients were asking whether the degree of asset value cuts they had made were similar in size to those of other companies.
PE companies and their executives regularly use sophisticated math to evaluate investment opportunities, estimate future cash flows, and compare companies to industry baselines. And yet, there was great variation in volumes and timing, rather than the immediate response of public markets. “How objective are these appraisal-based values when timing can be chosen selectively?” Costello asked.
MSCI also looked at data on the weighted average differences between appraised values and sale prices. Globally, the figure was -2.0%. Switzerland was +8.8%. Italy and Japan, +4.9% and +4.6% respectively. The UK came in at -0.7% and France, -2.5%. Canada, -4.0%. The U.S., -6.8% — the worst performance of any global region in MSCI’s annual review of the topic.
To be clear, neither Costello nor anyone else at the company accused any private equity real estate fund of acting inappropriately. However, the point is that at a time when property valuations are falling, there might be “perverse motivations” and “skewed incentives” for managers to try hiding that asset values were falling until, possibly, markets could rally and the values recovered.
Another data point is that appraisals for central business district offices fell by 43% from peak values to midyear 2024. And yet the RCA commercial-property price index (CPPI), which shows transaction prices were off 51% from the peak values. It helps illuminate the suggestion that managers should use multiple forms of validation like third-party datasets and other measures of performance for greater transparency for limited partners.
