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Matt Malone on how Fed rate cuts could affect private markets, particularly private equity and real estate
Key Takeaways
- The Fed's rate cut cycle may lead to an increase in transaction volume and deployment of dry powder, potentially benefiting private equity and real estate as leverage becomes less costly and valuations improve.
- Private equity could be a key beneficiary of falling rates, while private credit may experience increased competition and potentially lower return expectations due to the abundance of available capital.
- In commercial real estate, falling rates may not immediately unlock transaction volume, leaving it a lender's market for now, especially as capital raised for real estate strategies remains limited compared to private credit.
Transcript
What we're seeing now is the fed is beginning a rate-cut cycle. Inflation is slowing down and nearing targets. We are seeing some weakness in the labor market which can be concerning. But when we look at the impact of rates on private markets largely this is going to be a tailwind for private markets and a positive thing. As we've seen private markets evolve over this quick rate hike cycle, we've seen generally transaction volume go down and dry powder go up.
And what the beginning of this rate falling cycle will be is we're going to start to see unlocking of transaction volume. And we're going to start to see a lot of that dry powder come off the sidelines. Strategies that are going to benefit the most are strategies that use leverage. So think private equity and real estate equity. I think in general, private equity will be the first beneficiary, because of the amount that cap rates have fallen in real estate, there's going to be need to be more rate cuts for the real estate market to get back in equilibrium, but ultimately falling rates will be a tailwind.
They'll also help with valuations we've seen in the market. So there's been a lack of transaction volume, partially because people don't want to, take new marks. But with a falling interest rate that's going to reduce the, the discount rate when you do valuations. So that should ultimately help boost valuations. It should take some pressure off of leverage strategies like private equity. And it should unlock transaction volume. There's a lot of need for liquidity in the market. And I think that this this falling rate cycle will start to do that. And I think as that transaction volume gets unlocked, that will help drive, the economy and hopefully bring back some, some positive momentum in the job market as well.
The next question is what strategies become more or less attractive in this environment. And you know, clearly it seems to me that private equity is going to benefit a lot. Private credit, on the other hand, with rates falling, you should expect to see forward, return expectations in the private credit market start to fall.
So you're going to see rates coming down which will bring potentially private credit returns down. Also, there's a ton of dry powder in private credit. So there should be a lot of supply. So that market is going to continue to be very competitive. So I think the balance of power may shift in the in the private credit, private equity world.
And then in real estate, I still think, it's a bit of a lender's market. Cap rates got compressed so low that, interest rates are going to have to fall significantly to unlock a lot more transaction volume. So I think that lenders with creative solutions can be opportunistic in a market like this, even though rates may come down a bit, I still think it's a lenders market in in the commercial real estate market because you haven't seen as much capital get raised for those type of strategies versus the private credit market, which generally focus on corporate transactions.
And then of course, we look at venture capital. I mean, venture capital doesn't really use leverage. The interest rate environment is has less of a direct impact on venture capital. But I think falling interest rates should generally be positive for the venture capitalists as well. As markets start to loosen up and hopefully liquidity comes back in the markets in general.
So that's the way we're looking at, sort of tactically how this is going to impact private markets today.
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