The economic environment can have a significant impact on merger and acquisition activity while specific market sectors may experience even greater volatility in the number of business transactions as the economic cycle changes or shifts from expansion to contraction.
This article provides an overview of merger and acquisition trends, transaction volumes, and some common themes expected to impact deal making activity within the real estate and construction industry sector from a US macroeconomic perspective.
Real estate and construction firms often use mergers and acquisition strategies was a way to increase revenues, scale up, improve market position, or expand geographic footprints. Acquisition targets can also create strategic opportunities and reduce exposure to areas of risk and enhance a company’s agility and resilience.
M&A Activity
During the first quarter of 2020, global M&A transactions hit a record setting $1.3 trillion in value and posted a 94 percent increase from the first quarter of 2019. It was no surprise that technology led the increase with S&P Global, Inc.’s acquisition of IHS Markit Ltd. for $43.6 billion and NVIDIA Corporations’ $38.6 billion acquisition of Softbank Group.
Special purpose acquisition company transactions also contributed to the mix as SPACs became a popular fast track to market. Easy access to capital and lower cost debt financing in 2020 further fueled the record setting deal environment.[1]
The onset of the Pandemic in the spring of 2020, put M&A transactions temporarily on pause as the number of announced transactions fell from 1,435 worth $87.2 billion in January, to less than 700 transactions worth $24.6 billion by the end of May.[2] The dramatic decline was the result of growing concerns about the global economic impact of the Pandemic and the strict measures taken by central governments to contain the spread of COVID-19. The slower pace of transactions ultimately proved transitory as the volume of transactions quickly increased, reaching 2,000 total deals worth $278 billion by the end of 2020.
In 2021, global M&A transactions set an even more impressive record with 62,193 deals worth $5.8 trillion, far surpassing the previous record set in 2007 with deals valued at $4.5 trillion. Companies with significant cash balances generated during the pre-pandemic economy were able to take advantage of strong balance sheets, low-cost financing, soaring stock markets, and increased confidence to pursue larger market transactions. Deals in the US led the way and accounted for half of total transactions worth $2.5 trillion.[3]
The pace of M&A activity in 2022 did slow when compared to the record levels achieved in 2021. A much more aggressive monetary policy stance taken by the Fed raised concerns about the probability of economic recession and increased the level of uncertainty felt throughout US markets.
The first half of 2022 saw a 25 percent decline in M&A transactions when compared to the first half of 2021 with only 15,764 deals announced representing $2.2 trillion in value. Transaction volume was negatively impacted by the world’s largest economies raising interest rates in response to runaway inflation, while stock markets turned bearish.[4]
The second half of 2022 saw additional declines as the Fed drove interest rates higher and deal makers began to question a “soft-landing” scenario. A growing consensus during the second half of 2022 regarding the probability of a US recession once again pushing M&A activity levels lower. Following the second half downturn, global M&A activity appeared to bottom out at 7,122 global transactions, reflecting a total value of $3.6 trillion by the end of December 2022.
For businesses planning to execute a growth through acquisition strategy in 2022, the cost of debt financing drove the cost of acquisitions higher making it more difficult to achieve required hurdle rates of return. Higher leveraged transactions that would have worked in a lower interest rate environment quickly became economically unfeasible. By the second half of 2022, many potential acquirors with cash on hand from government stimulus programs found it difficult to keep up with the rapid rise in inflation, lingering labor shortages and dwindling cash reserves put transactions on the back burner.
Real Estate
During the second quarter of 2022 before transaction levels slowed, real estate, which has historically proved a good hedge against inflation, was the second most active sector accounting for $53.3 billion in total transaction value. The top three real estate transactions included the $27.4 billion acquisition of Duke Realty REIT by Prologis. Prologis (also a REIT) is considered a leader in the logistics real estate asset sector and provides solutions to address the energy & sustainability, mobility, and digital needs of tenants and customers. This deal reinforced the importance of logistics and the critical role this asset class plays in global commerce. This asset class has proven an attractive investment due to its outperformance of other asset classes during and after the Pandemic.
The second largest real estate deal was the $13.1 billion acquisition of American Campus Communities by Blackstone. American Campus Communities is the largest owner, manager, and developer of student housing communities in the US with a portfolio of 166 properties in 71 university markets.
Finally, the third largest transaction was the $11 billion acquisition of Healthcare Trust of America by Healthcare Realty Trust.[5] These large transformative deals pushed the real estate sector up in the ranks to the fifth-highest market sector during the first half of 2022.
Commercial real estate investment activity changed in the second half of 2022, as inflation continued to climb and interest rates increased, the higher cost of debt financing took its toll on real estate investment transactions. The second half of 2022 saw the number of real estate transactions decline to 91, accounting for just $1.9 billion in value. This significant decline in real estate investment deals and total value, reflected softening in overall M&A activity as well.
It is interesting to compare the change in commercial real estate property investment by asset class over time. The following table presents a summary of the year-to-year change in commercial real estate investments in the US by asset class from 2020 to 2022.
| TABLE 1 | |||
| Property Type | 2020 | 2021 | 2022 |
| Retail | -42.8% | 83.6% | 4.7% |
| Hotel | -68.4% | 238.4% | -0.6% |
| Total | -33.5% | 85.9% | -16.7% |
| Industrial | -15.9% | 52.5% | -17.1% |
| Multifamily | -27.6% | 117.0% | -18.9% |
| Office | -40.2% | 55.2% | -24.8% |
| Other | -47.5% | 71.3% | -40.5% |
As presented above, commercial real estate investment value in the US saw significant growth in 2021, following the initial sock from the Pandemic. Similar to the decline in real estate investments between 2019 and 2020, overall real estate investments decreased 16.7 percent in 2022, but across asset classes, investments fell between 1 percent in the Hotel sector to almost 41 percent in the other real estate investment class. Retail property investment was the only real estate asset class that recorded an increase during 2022.[6]
It is also interesting to note there has been a significant shift in the type of asset class investments by REITS. Since 2005, the traditional asset class investments made by REITS had historically focused on apartments, industrial facilities, lodging, office buildings, and retail facilities. The current investment trend has been on alternative asset classes which include, data centers, medical office buildings, self-storage facilities, senior housing, student housing, cold storage facilities, laboratories, and manufactured homes. In 2005, traditional asset class investments accounted 62 percent of REIT portfolios and alternative asset class investments 32 percent. By 2021, the REIT asset class investment portfolio mix reversed with 68 percent of REIT portfolios focused on alternative asset classes and 32 percent in traditional asset classes.[7] The investment portfolio mix clearly aligns with the changing demographics and overall composition of the population.
Engineering and Construction
M&A activity in the engineering and construction sector followed similar trends as overall merger and acquisition activity. The engineering and construction industry sector reported 3,890 transactions worth $358 billion during 2022 which represented a decline of 33 percent in total value. Transactions by North American market participants led overall deal activity, with 1,500 deals announced worth $172 billion.[8]
During the first half of 2022, there were several transactions within the engineering, industrial services, and utility-contractors subsector. Financial sponsors and sponsor-owned companies were the most active as several consolidation strategies were completed. The second half of the year saw a drop in engineering and construction M&A activity due to the rising costs of capital, higher rates of inflation, and greater uncertainty regarding the US economy.[9]
Some of the more notable transactions that occurred in the engineering services sector included Alpine Investors expansion of its engineering services platform, Trilon Group, which made several acquisitions in the second half of 2022 including: Ramey Kemp Associates, CPH Corporation, DRMP, Inc., ESI Consultants, and Waggoner Engineering.
Notable transactions within the construction and industrial services subsector included Sterling Industries acquisition of Petillo, Inc. in January of 2022, followed by the acquisition of Concrete Construction Services of Arizona, LLC in December. Kohlberg & Company, LLC’s August 2022 investment in USIC and EMCOR Group’s August acquisition of Gaston Electric Co. which will continue to expand EMCOR’s footprint in the northeast.
While overall construction activity began 2022 on a strong note, the industry the was impacted by deteriorating economic conditions. According to the Dodge Construction Outlook 2023, after climbing an estimated 17 percent in 2022, construction starts are expected to flatten during the year reaching total spending of $1.083 trillion for the year. Dodge projects nonresidential building starts will decline 10 percent to $375 billion, residential starts will remain unchanged at $427 billion and nonbuilding starts will increase 16 percent to $281 billion. Dodge expects the economy to narrowly avoid recession in 2023, with greater-than-normal economic volatility and a less certain construction outlook persisting through the year. With supply chains yet to return to normal, Dodge expects construction materials prices to remain elevated in 2023[10].
On the positive side, nonbuilding construction will be more insulated from economic turmoil than other sectors by the recent passage of several legislative efforts to fund and support US infrastructure rehabilitation and development.[11]
Outlook
While it is impossible to predict with any degree of certainty what will happen in the macroeconomic environment, there are indications that the Fed’s interest rate policy is working. Lower inflation readings should help drive some badly needed stability in the stock market. Market stability could in turn be a driving force that leads to greater confidence in the US and global economies which may open the door for more M&A transactions.
The lack of financing played a significant role in the decline in overall M&A deal activity during the second half of 2022. More leveraged deals could no longer meet required hurdles rates given the higher cost of debt. Assuming macroeconomic conditions do improve, and interest rates stabilize, access to financing should improve for high quality transactions.
Legislation is also expected to stimulate more transactions. President Biden’s Inflation Reduction Act represents a solid step forward to support the growth and adoption of clean energy. The magnitude of financial incentives is expected to bolster the level of private investment and should stimulate M&A activity within the clean energy sector. Market participants within the Oil & Gas market sector and private equity interests are expected to seize the opportunity to capitalize on this stimulus.
Similarly, the CHIPS and Science Act has already stimulated the construction of new US manufacturing facilities to revitalize domestic manufacturing, bolster the strength of US supply chains, and accelerate the growth of new industries for our future. New investments in memory chip manufacturing by Micron Technology and GlobalFoundries will boost domestic semiconductor manufacturing and stimulate additional private investment for decades to come.
Conclusion
Since the beginning of 2023, volatile equity markets and the rising interest rate environment have increased economic uncertainty. Investors have remained on edge and continue to tread cautiously as the Fed works diligently to reduce inflationary pressures and bring some stability to the economic landscape. Higher interest rates and the availability of capital combined with greater uncertainty are expected to impact M&A activity in the real estate and construction industry sector for the near term.
It seems likely that smaller or midsized deals may become more prevalent until economic stability returns to encourage greater confidence and conviction for larger value deals. We may see buyers armed with significant war chests take advantage of strategic and transformative opportunities as valuations come under additional pressure until the next cycle.
ValuQuest. LLC, a subsidiary of Bonadio & Co., LLP helps clients understand the value of their businesses and potential acquisition targets. Our professionals routinely provide valuation and financial reporting assistance for our clients in the real estate and construction industry.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
[1] Forbes, April 19, 2021
[2] FactSet Research Systems, Inc.
[3] Reuters, December 20, 2021
[4] M&A Highlights First Half 2022, July 6, 2022
[5] Ibid.
[6] statista.com/statistics/1215470/property-investment-volumes-usa-by-property-type
[7] JLL M&A Strategic Transactions Monitor – October 2021
[8]www.globaldata.com/store/report/construction-industry-m-and-a-deals
[9] Engineering & Construction Annual Update stout.com
[10] Dodge Construction Outlook 2023
[11] Ibid.
