Benefit Street Partners is refactoring its lending priorities for 2023 as commercial real estate debt funds across the US struggle to find their rhythm amid today’s market volatility.
Michael Comparato, managing director and head of real estate at the $30 billion New York-based alternative credit manager, told Real Estate Capital USA the Franklin Templeton company is finding it hard to navigate debt and equity markets because of widespread uncertainty from interest rate hikes, inflation and increasingly expensive capital.
“Debt is the tail wagging the dog of equity a lot of times, and we are lending to people today at coupons in our bridge lending business in the 7 to 7.25 [percent] range. It is the cheapest money we have, and more often than not, [it is] 8 and 9 percent,” Comparato said. “When debt costs are that high, it’s really difficult to invest equity.”
With the current market, Comparato said there is built-up negative leverage in the system, and historically that has not worked well for equity components. Adding to this, investors today have been conditioned to 40 years of declining interest rates and borrowing a 3- or 4-percent fixed-rate loan for 10 years, he said.
The change of markets is arriving for BSP after a third quarter where the firm remained an active lender through more volleys of rate hikes installed by the US Federal Reserve. Between July and September 2022, the company closed $470 million of loan commitments, funded $433 million of principal balance on new and existing loans and received loan repayments totaling $355 million – marking $99 million of net growth in the firm’s core portfolio.
BSP saw a shift in its loan terms over the last year on scale with other alternative lenders and debt funds active in the market.
Comparato said the company went from being one of the cheapest and first options – with a 2.5 to 2.75 coupons – to being one of the last options compared to borrowing from banks and life companies.
“Volume is tough on the debt side, because a lot of people are looking at equity the way I do. If the equity is not transacting, it is this vicious circle,” Comparato said, noting this lack of equity leaves no avenues for debt to make deals accretive. “The net of all that is cap rates need to move wider and debt costs need to move down and I am not sure that either one of those is happening quickly at this point.”
Comparato said the market will find its equilibrium over a to-be-determined period but noted the illiquidity of the asset class makes it impossible to pull up a computer screen and get an immediate price for an asset or debt opportunity.
Despite becoming one of the more costly sources of debt financing, the opportunity well has not run dry for debt funds such as BSP because of the widespread slowdown seen among national bank lenders. Where deal assumptions have changed and funding gaps are created, Comparato said debt funds and mortgage real estate investment trusts have stepped in to plug the gap.
“It’s very different than [during the GFC], and it’s very different than the first two quarters after covid-19 where you could make 25 phone calls and not find capital,” Comparato said. “Capital is out there; it is just priced at a level that people do not like.”
Comparato said he does not see a reason to write an office or retail loan in the current market, noting it is not because of a pending catastrophe for either sector. Instead, BSP is not getting adequately paid for taking the additional risk.
“What I know there is not going to be is a multifamily apocalypse,” Comparato said. “Asset prices might reset, but until Amazon comes up with a way to replace the need for shelter, people need a place to live, hang their hat, raise their kids and put their kids in school.”
BSP is seeing better opportunities in hospitality now compared with retail and office. Comparato said the firm finds the leisure side of hospitality to be very investable considering BSP can get paid appropriately there. He noted the firm is selective on airport hotels, conference center hotels and business-only hotels because work travel may be modified for a long time following the covid-19 pandemic.
BSP is generally a short-term value-add lender across all sectors, and while it may not be the most aggressive lender in the market today, Comparato said the firm is still wide open for business and looking to put capital to work.
Comparato said industrial and grocery-anchored retail remain favorable in the firm’s view, with the latter being focused on half-empty shopping centers with no anchor and a business plan to convert into a more efficient grocery-anchored center. “If you have a grocery-anchored shopping center that is 90 percent leased and the grocery store has 10, 12 or 15 years left on the lease, that loan does not walk into my shop,” he noted.
Comparato added he is generally not looking to take the reposition risk on a retail asset today, though there may be a time and level where BSP would more thoroughly consider it.
Hurdles and headwinds
With the commercial real estate collateralized loan obligation and commercial mortgage-backed securities markets hitting a wall this year, BSP similarly saw its conduit loan activity taper too.
In the third quarter, the firm closed $7 million of fixed rate loans that were sold or will be sold through its conduit program and over the same period sold $94 million of conduit loans for a gain of $4.8 million.
Comparato said the CMBS and commercial real estate CLO markets have slowed down significantly in part because lenders would need to write loans with coupons of close to 7 percent for deals to be profitable. He noted the market is having a deer in the headlights moment where investors do not know what to do because costs have doubled or tripled in a matter of a few quarters.
“These assumptions broke their model, and some of these people just do not want to accept reality that this is where debt is priced right now,” Comparato said. “Maybe it gets better, but honestly I do not think it is getting meaningfully better anytime soon.”
One bright spot amid the current volatility akin to what was seen in the first quarter of 2020 is the loan opportunities. “We wrote some of the best loans in the history of the company in 2020, and I think we could see those opportunities again in 2023 and 2024,” Comparato said.
Almost uninvestable equity
Comparato said the market is in the early innings of what is going to be a tough period for commercial real estate on both the debt and equity sides.
“A lot of equity investors are going to lose a lot of money. There are going to be a lot of loans that go bad and there is going to be a lot of loan sales at discounts,” he said, noting 2024 could potentially be worse, considering the sheer volume of deals signed in 2021 with two- and three-year maturities coming due in future quarters.
“For our equity business, we are finding the market to be almost uninvestable,” Comparato said. “There is a level of uncertainty that is very hard to navigate right now.”
BSP is comfortable as an equity owner and can work out any foreclosure situations. “We are not the type to hide under our desk, hunker down and get through it,” Comparato said. “We want to be active, because volatility usually leads to opportunities.”
Part of the market’s return to its prior form would require a similar pathing back to lower interest rates, which could take until the end of 2023 or after in the eyes of some commercial real estate market participants.
“The Fed has been very transparent and they have made it abundantly clear they are going higher and they are going to stay higher for longer,” Comparato said. “There are a lot of equity guys out there that have convinced themselves that rates are going to come back down in the near term; I just do not see it.”