Funds Are Sitting On Billions In Dry Powder. Will They Actually Spend It?

Global private equity and venture capital funds have a record $2.6T in uncommitted capital waiting to close deals, according to S&P Global. 

And in recent earnings calls, some of the biggest names in commercial real estate, including Blackstone, Starwood and TPG, said they have billions to spend. But investors and analysts have their doubts about how much of it will be deployed.

“That dry powder is big capital — they're conservative and they're reasonable — and there's still a huge disconnect between their wants and desires and the market’s wants and desires,” said Jeff Klotz, CEO of the Klotz Group of Cos., which invests primarily in Southeast multifamily assets. 

While total investment sales volume has risen monthly from April through June, according to data provided by MSCI Real Assets, the dry powder that has been sitting on the sidelines remains largely uninterested as they continue to wait for steeper discounts to deploy capital. Apart from a handful of high-profile deals, those opportunities have yet to materialize. 

“A lot of that dry powder, it's still forced to sit on the sidelines,” Klotz said, as the divide between what buyers will pay and what sellers will accept remains a canyon.

The 25 private equity and venture capital firms with the most uncommitted capital have accumulated more than $556B for acquisitions, more than 21% of all dry powder, according to S&P Global. KKR & Co. leads the way with $43.8B, just ahead of Apollo Global Management's $41.6B. 

But smaller players are also competing in the space. Miami-based alternative investment manager BridgeInvest just closed a $670M fund that it plans to deploy across $1.2B in transactions in the next 24 months. Across the country, fund managers are sitting on capital that is in search of steeply discounted acquisitions that are few and far between. 

“There's a lot of distress pent up that has not worked its way through the system,” said Lonnie Hendry, chief product officer focused on commercial real estate debt at Trepp. “For the dry powder narrative to play out at scale, those larger distressed opportunities have to come to market.

“Bank portfolios or large numbers of loans have to hit the market, and we just haven't seen that yet. I think it's coming, but it hasn't played itself out to this point.”

U.S. real estate transactions totaled $42.6B in June, 3% higher than during the same period a year earlier and the highest volume since December 2022, according to MSCI. While activity is trending up, it still lags most of the last five years.

Assets coming to market today tend to be those that must trade — because the property has a refinance date coming, a weak rent roll or negative cash flow, for example — but values haven’t fallen enough to add significant capital to the sector.

“There's been very few instances where we've seen the market reach the point that those dry powder buyers are looking for,” Moody’s Analytics Director of CRE Economics Matt Reidy said.

The office market has seen the greatest uptick in steeply discounted deals, Reidy said, but overall volume remains relatively small. 

Last month, PMC Property Group acquired the Three Parkway office tower in Philadelphia for $30M, a 74% discount on its 2017 purchase price. 

Earlier this month, the lender of the iconic Waldorf Astoria in Washington, D.C., acquired the property at a foreclosure auction for $100M. Miami-based CGI Merchant Group had paid $375M for the property in March 2022.

In New York, UBS took a nearly 98% loss on the office building at 135 W. 50th St. in an online auction, and the 526K SF Proscenium office in Midtown sold for $83M, a 30% discount from its sale price two decades earlier. 

Seven office buildings traded in the second quarter at a more than $100M discount from their previous sale price, compared to three such sales during all of 2023, Reidy said. Still, there are only so many properties in such dire straits. 

“I could probably rattle off the eight or 10 transactions that meet that criteria” of a steep discount, Hendry said.

“That's the real challenge. If there were 200 of them, we wouldn't be having this discussion.”

Analysts and investors expect the Federal Reserve to play an outsized role in future transaction volume.

Just as investors began to accept rate cuts may not be forthcoming, a weak jobs report this month flipped the narrative. Wednesday’s consumer price index report, which saw inflation dip below 3% for the first time since 2021, has buoyed expectations that the Fed will cut rates in September, adding liquidity to the commercial real estate market.  

“A lot of the dry powder is either, one, waiting for interest rates to come down or, two, waiting for massive distress, and that's not really seeming to develop,” said Holly MacDonald-Korth, CEO of bridge lender and investment firm KDM Financial. “I’m not sure if another shoe is going to drop in that department.”

In past cycles, the expectation of rate cuts could be enough to bring sidelined capital back into the market. But the whipsaw of competing economic signals has led investors to take a wait-and-see approach rather than include guesswork in their underwriting, MacDonald-Korth said. 

“Given the volatility we've seen over the last 12 months, I don't think anyone's pricing anything in beyond a few days from now,” she said. 

When rates do move, more properties are expected to come on the market.

Matthew Sharp, co-founder of multifamily investment company Hamilton Point Investments, said a 50-basis-point rate cut would allow his firm to bring half a dozen properties to market. He has tried to offer other stabilized and performing assets in recent months but has had limited success.

“It's been torture trying to get them sold,” he said. “You get a few bids from groups you've never heard of before, and they actually never had any money.”

Rather than targeting steep discounts, Sharp’s firm is looking to acquire multifamily assets in Sun Belt states where record levels of construction have depressed rent growth and weighed on valuations. The new apartments will get absorbed, the thinking goes, and prices will bounce back. 

“We're absolutely buying,” he said. “If we're buying at 20% less than this stuff sold for two years ago, I'm cool with that. It's going to get back to where it was.”

Whether steeper discounts become the norm, especially in the office sector, is hotly debated. Some investment firms, most notably Blackstone, have said they believe multifamily prices have bottomed out, while still more think the limited transaction volume has kept asset values from falling. Office values are harder to pin down.

Even if prices crater, Moody’s Reidy still has doubts that there is as much capital waiting on the sidelines to scoop up assets as advertised. 

“Anytime there's a whiff of distress in the real estate market, you see a deluge of stories about dry powder waiting to come in. It rarely materializes or hits the level that they were planning on,” he said. 

Lenders during this cycle have been more amenable than in past moments of stress to extend loan terms and negotiate with the sponsor to keep debt in good standing. With a rate cut potentially on the horizon, analysts and investors expect many creditors to stay on that course.

“Lenders are so afraid of how much bad debt they have,” Klotz said.

They worry “that once they start to put the pressure on the borrower, once they start to realize it, it's going to start an avalanche.”