Crow Holdings believes disparities between strong sectors and struggling sectors and a plethora of banking system-related woes make for a more complex situation than is generally understood, with managing director of research Mark Roberts describing this disconnect as a “myth-versus-reality conundrum.”
“Times like these are great because there’s opportunity, if you can sort through fact versus fiction, as to what’s really going on in the market,” Roberts told Real Estate Capital USA.
There are two main areas to think about, he said.
“One has to do with the tenant demand side for real estate, which is all about businesses, households, consumers and how they are doing. The other is looking at what’s taking place in the capital markets with interest rates and how that impacts everything from valuations to transactions to development.”
Roberts spoke to REC USA not long after the Dallas-based investment and development firm published its latest whitepaper, which highlights key considerations when looking at today’s market – the US banking liquidity being one.
“During the first quarter of the year, the pullback from regional banks took centre stage over inflation but in recent months, attention has shifted away from depositor withdrawals to commercial real estate loans than banks hold and the risks those may present,” the report reads.
But the situation is more nuanced, with Roberts stressing that loan loss recovery is a key concern for smaller bank lenders. Larger banks will be better able to withstand losses than their smaller counterparts.
Another area where myth versus reality conundrum is present is in the office sector.
“Looking at San Francisco, New York, Chicago, there are fewer people coming into the office every day,” said Roberts. “It is really about looking at the individual buildings [but it is also] a matter of who really has the balance sheet flexibility to attract and retain tenants.”
To attract tenants, those landlords who have the financial balance sheet flexibility and capital availability to fund the improvements that is needed stand a better chance of competing.
“The tenant will pay them back through their rent,” said Roberts. “This means landlords who applied lower leverage on their building, may perform better than other types of landlords.”
Still, even when the fundamentals of a sector are strong, it is the health of the capital markets that needs more attention.
“There is a modest amount of distress in the capital markets as it relates to office properties and certain dilapidated malls, although it is not widespread in other real estate sectors,” said Roberts.
“What is going on in commercial real estate is not unlike what’s going on in the housing market,” he added. “When mortgage rates went up, people stopped buying homes. And same things happening when the lending rates are going up, there has been less transaction activity that’s taking place and development activity has slowed. You can also see this in the GDP figures for new construction.”
There is another piece of the puzzle when addressing the nuances of what is really happening in the market and how it appears. And that is the attractiveness of taking out long-term versus short-term debt.
“If you think loan costs, mortgage costs, interest rates are going to be lower in a year than they are today, what are you likely to do? You’re going to wait, right until those rates go lower,” said Roberts. “And I would be surprised if some of those do not have an option to float lower.”
Many real estate loans are priced off the SOFR yield curve.
“If a borrower expects lower interest rates today, why borrow at the shorter end of the curve where rates are higher?” asks Roberts.
At the same time, deciding to borrow longer duration assumes a longer holding period. The choice really depends on the borrower’s view of the future and how long they intend to hold the asset.
“Many institutional owners will try to stagger their loan maturities to capitalize on the inverted yield curve and minimize their refinancing risk.”