Canyon’s Potts: It’s about picking the best spots in the capital stack 

Dallas manager finds better debt opportunities compared with equity deals. 

Canyon Partners is approaching the dislocation in the commercial real estate capital markets with a particular mindset – it is all about picking the best spots in the capital stack, Robin Potts, chief investment officer, told Real Estate Capital USA.  

The Dallas-based manager, with more than $24 billion of assets under management in the real estate and corporate sectors, does direct lending and makes equity investments in the value-add and opportunistic spectrum across all major property types in primary and secondary markets in the US. But right now Canyon finds the most value in the debt sector, Potts said. 

“When you have periods of volatility like this, the equity markets can take a lot longer to adjust than the debt markets. Because the debt markets tend to move first, the opportunities in the debt markets have been incredibly interesting and that is where we have been spending most of our time,” Potts said. 

The firm’s real estate platform is set up to look at transactions from a debt and equity perspective, with a skill set that ranges from capitalizing ground-up development and repositioning projects to investing in distressed and rescue capital situations.  

“It is a very wide range of situations across the capital stack,” Potts said. “Because we have the opportunity to look across both debt and equity opportunities, we can approach situations as a lender or as an investor that wants to take equity risk in a situation. Obviously, the markets this year have been incredibly frozen and what has risen to the top of the opportunity set for us has been in the debt space.” 

Alternative manager opportunity 

The commercial real estate market is in the midst of a well-documented reset in valuations, which has resulted in a huge freeze in the debt and equity markets on a year-over-year basis. In Potts’ view, this represents generational opportunity within the credit space. 

“As traditional lenders have pulled back, there is a tremendous opportunity for alternative managers to step in to where the gaps have been left by traditional lenders,” Potts said. “This sets up alternative lenders with the ability to do very traditional lending that was previously captured by banks with best-in-class borrowers at lower attachment points.”   

Although the transaction markets have been slow to unlock, Potts believes there is too much maturing debt for the current situation to persist for much longer.  

“The majority of the debt generated over the past few years was floating-rate and has interest rates caps that are going to be resetting,” Potts said. “There are very strong assets that have balance sheets which aren’t sufficiently capitalized, however, to survive a massive increase in rates.”    

Further, there continues to be a gap between what senior lenders will offer and sponsor equity for many properties that need to be refinanced. “The cash-in refinance is the only option that exists today for many assets,” Potts said. 

Sponsor needs 

In her conversations with sponsors, Potts says the top concern is the ability to source accretive debt for acquisitions and refinancings. Sponsors – and lenders – are also looking for a functioning valuation market and a market in which there are more narrow gaps between buyer and seller bid-ask spreads. Additionally, the market needs a period of greater economic stability and less volatility from the banking sector.  

“What is happening today is unwinding the widely accepted investment metrics of real estate over the last few years in short order,” she added. “While there is a lot of optimism that rates will go down in the last half of this year, there are also concerns about the pressure on balance sheets if that ultimately does not come to pass.”  

Because the debt capital markets underpin the overall industry, sponsors are starting to have to make difficult decisions. “There are assets where the cost of waiting is no longer possible as it requires significant additional capital,” Potts said. “We are starting to see rescue capital situations for assets for entities or portfolios where the sponsor doesn’t have the benefit of time.”