AXA’s Curlow sees increasingly compressed distressed cycles 

The question of where values sit is hanging over the market, made harder to answer by a lack of trades.

As the commercial real estate market heads into what is widely expected to be a period of distress, Justin Curlow, global head of research and strategy at Paris-based AXA IM Alts, believes the length of this part of the cycle will be shorter than during previous downturns.

Curlow, speaking to Real Estate Capital USA at last week’s MIPIM conference in Cannes, France, underscored that he saw investors and lenders facing an unusual market. In addition to a gap between buyer and seller expectations, there continues to be a similar divide between borrowers and lenders that is exacerbated by a rising rate environment.    

“The rate of interest rate increases has meant a higher cost of capital as well as an opportunity for alternative lenders to provide debt capital. Banks have been challenged and sponsors have had a difficult time solving the debt funding gap,” Curlow said. 

Still, the commercial real estate market has been through enough downturns that it has matured significantly since the 1980s. This is evidenced in part by the greater institutional capital that is holding and lending on these assets.  

“I feel like the market is taking its medicine with regard to valuations more swiftly than we did in the past, and that valuations are correcting more swiftly,” Curlow said. “Post GFC, it took about 12 months for this to happen in the UK but in the late 1980s, it took approximately 26 months. Hopefully this compressed time frame will allow us to rebound more swiftly than what happened during previous cycles.” 

While the bank failures in the US and UBS’s acquisition of Credit Suisse may have increased near-term volatility, Curlow – like many other market professionals at MIPIM – cautioned against drawing too many conclusions. “We are watching the story unfold and waiting to see how far the tentacles will reach,” he said.  

The valuation question 

The question of where values are remains a significant one, particularly because there have not been a substantial number of trades. Curlow, however, notes that valuation experts and appraisers are getting creative about how to estimate the value of a property. 

“There is a sense the valuation community is not necessarily waiting for hard evidence of completed deals and is looking at the capital markets for anecdotal evidence,” Curlow said.

Curlow gave a hypothetical example of how valuation experts might interpret a situation in which bids came in about 20 percent lower for a property being shopped for $100 million.  

“In that scenario, it becomes apparent that $100 million is not a supporting value – and that is a very progressive step,” Curlow said. “There are still existing owners holding onto the reality of yesterday’s prices and not generating market-clearing prices.” 

This situation is playing out first in the UK, although Curlow sees emerging evidence this is starting to happen in Continental Europe as well. “There is a sense this will allow us to get back to some level of liquidity,” he added. 

There is also a growing sense of the importance of commercial real estate debt as an investment and of the role it plays, particularly in times of distress. “We are seeing more of the investment community understanding that at this point the relative value currently sits with debt. Debt was the first and the swiftest part of the market to adjust,” Curlow said. 

Key questions for 2023 

While 2022 started with a number of positives, including the availability and distribution of vaccines for covid-19, reopening economies and a rebound in demand for commercial space, “economic growth was curtailed by factors that included a zero-covid policy shutting down China and also an inflationary story that was exacerbated by the invasion of Ukraine and the energy crisis in Europe,” Curlow said 

Key questions in 2023 will be around sectors facing headwinds, with Curlow noting that despite its troubles, office continues to be the biggest and most traditional asset class.  

“There is a structural shift that is happening in the office sector as behaviors post-pandemic evolve. High-quality, well-located and well-amenitized office space is seeing strong leasing activity in Europe with strong rents being paid. In part, it is about the human capital and making sure people are happy and want to come to the office,” Curlow said.

But the risk of obsolescence is real. “There is almost an onus on companies to trade up into more modern, purpose-built properties, which are few and far between in Europe, which will leave behind stranded assets and capex needs,” Curlow said.  

There is also a strong regional difference, with Curlow noting the pressures in the US are more acute than those in the UK, Europe or Asia. This is due to a variety of factors, including the larger size of homes, commute times and employment market, as well as corporate culture in relation to work from home in the different regions, he added.