The role of private equity and real estate in investor portfolios may differ, but the outlook for both asset classes in 2018 continues to have much in common: too much money, too high prices and lower returns.
At the same time, the economy is a wild card. Nine years after the last recession, real estate and private equity investors continue to expect a downturn but have no clue as to what could rain on their parade. And they have been expecting the downturn for the past few years.
Real estate funds have a combined $244 billion in dry powder as of Sept. 30, up from $223 billion nine months earlier, according to London-based alternative investment research firm Preqin. Private equity managers are sitting on $954 billion in dry powder, up from $826 billion, Preqin data show.
There is a 1-in-4 chance the economy will hit a speed bump in 2018, said Andrea Auerbach, managing director, Menlo Park, Calif.-based head of global private investment research at Cambridge Associates LLC.
Private equity investors have a diversified array of options, including private credit, growth equity and sector-focused funds. In the 1990s, the only option was "heavily leveraged buyouts," Ms. Auerbach said.
And, with the exception of 2008, every recession has had "a smaller blast radius" with only a few sectors of the economy being affected, she said.
Since the 2008 recession, certain sectors have been affected by "rolling blackouts" including retail and oil and gas, she said.
Investors can benefit by going into those sectors if they stick with managers experienced in that industry, Ms. Auerbach said.
"I think the challenge for investors going forward as the private equity industry continues to specialize and fragment … is to find areas that are less trampled by capital and take advantage of those," Ms. Auerbach said.
Some asset owners are considering such specialized areas as royalties, settlements and litigation claims, she said.
Real estate insiders are also keeping the economic cycle top of mind but agree that the asset class is in better shape than it was before the Great Recession. "Broadly speaking, we are in a maturing economic cycle, but it's pretty healthy," said Russ Devlin, Boston-based director of the research group at real estate manager AEW Capital Management LP. "The last downturn was caused by supply being out of whack."
Industry executives have been waiting for a recession and/or a spike in interest rates that never arrived — "although we are keeping our eyes on it," Mr. Devlin said.
Property supply is trending up and that's expected to continue to edge up, though more modestly than in prior cycles, he said.
"Vacancy rates are moving sideways, with no upward movement in office, industrial and multifamily sectors," Mr. Devlin said. "Even retail, it went down a tick or two but it is not what you would have thought. We think the death of the mall is exaggerated."