Published October 16, 2023 | 2 min read
Key Points
- Despite high interest rates, the construction industry remains strong, buoyed by low unemployment and demand for onshoring-related building.
- Amid high financing costs, private equity is using innovative structures to implement industrial M&A deals.
- Corporate buyers which have synergies with the target are still likely to prevail.
Construction defies dire predictions to outperform
Larry Grafstein: Can you give us an outlook on the housing market and the building product cycle?
Josh Rosenbaum: The overwhelming consensus was that 2023 would be a very difficult year for the markets. That would have meant a difficult time for anything tied to construction, which historically has been incredibly sensitive to interest rates. Yet here we are with mortgage rates at over 7% and homebuilders have been some of the best performers out there.
As long as you have low unemployment and people can cover their payments – 7% or otherwise – there’s going to be some activity. You also have a lot of people that are locked in at mortgage rates of 2.5 to 4%, and they’re not selling. If there’s very little supply, demand doesn’t have to be through the charts to drive pricing.
Obviously if rates come down and unemployment remains low, this space could get beyond interesting. Right now, residentials are holding in there. Non-residential people are worried about offices, but there’s a lot of need for suburbanization offices. There’s also onshoring – not just huge battery semiconductor plants, but all sorts of onshoring in the industrial manufacturing sector. So it’s actually been a pretty good market for building and construction.
“If rates come down and unemployment remains low, this space could get beyond interesting.”
Josh Rosenbaum, Global Head of Industrial and Diversified Services, RBC
Creativity is key to unlocking private equity deals
Vito Sperduto: In recent episodes we’ve talked about the changes we’re seeing in the private equity markets, and how leverage finance is impacting that. I would say there haven’t been as much, in terms of monetization, and it feels like they’ve been holding portfolio companies longer; the average hold period this year is about 5.6 years, up about half a year versus the historic norm.
Rosenbaum: I feel that the private equity market is moving in the right direction. The regular LBO for industrials has been dormant since the beginning of 2022. The deals that we’re seeing are largely where the existing seller rolls a lot, so reduces the need for debt, or even 50-50 deals where you can keep the capital structure in place.
It’s about bridging the bid ask gap. We’ve got base rates of 5% plus, and the junior capital is going to be higher, which we haven’t seen for a while. If that’s the cost of the capital, how do you get this deal done?
If you’re a private equity seller, the way you do that is to roll a portion of the equity, you maybe take something in the form of an earnout. You get creative to get to a headline price of multiple that works for you. If you’re the buyer, ditto.
I really feel that for a five-year hold, where you feel performance is going to be good, you’re going to see very innovative, smart people come up with structured solutions to get deals done.
“If you’re a private equity seller, you get creative to get to a headline price of multiple that works for you.&rdquo
Josh Rosenbaum, Global Head of Industrial and Diversified Services, RBC
Corporate buyers retain the edge over Private Equity
Sperduto: This past year, the corporates have outperformed the equity firms, just given that they had much better capital to play with.
Rosenbaum: Absolutely. Where there’s a natural corporate buyer with synergies, in theory they should prevail. Where there’s no natural corporate buyer, or the corporate buyer is distracted for whatever reason and the buyer is private equity, you’re having to see these customized solutions, which is good for bankers. We’ve been spending days on a couple of situations, just brainstorming how to bridge the bid ask.
“This past year, the corporates have outperformed the equity firms, just given that they had much better capital to play with.”
Vito Sperduto, Co-Head, Global M&A, RBC
