DWS’s Henderson sees debt opportunities on the horizon

Bank capital requirement changes and shrinking balance sheets are opening doors in multifamily, industrial and construction.

A rollback in commercial real estate lending by US banks is expected to open more opportunities for private credit lenders, especially in the multifamily and industrial sectors.

Todd Henderson, global co-head of real estate at DWS Group, told Real Estate Capital USA this week the door for private lenders – including the New York-based manager – could open further now after the Federal Reserve recommended additional capital requirements for US banks following a tumultuous first half of 2023.

“Large lenders are not adding new relationships at the moment; they are lending to their existing relationships,” Henderson said. “And across the board there is less liquidity, particularly for office in the debt space.”

Regional and national banks continue to be somewhat sidelined, a situation that could be further exacerbated by a July 10 announcement from Federal Reserve’s vice-chair for supervision Michael Barr which proposed a lower threshold for long-term debt and risk capital requirements. Following a nine-month review, Barr proposed banks with $100 billion in total assets to be subject to the requirements, versus the current mark of $700 billion.

“Events over the past few months have only reinforced the need for humility and skepticism, and for an approach that makes banks resilient to both familiar and unanticipated risks,” Barr said, referring to the March fallout of New York-based Signature Bank and San Francisco-based Silicon Valley Bank, as well as other regional banking volatility such as the May takeover of San Francisco-based First Republic Bank by JPMorgan Chase.

This stance means a change in approach for banks and alternative lenders.

“We are going to see the emergence of more private credit lenders or alternative lenders, because smaller banks and regional banks are going to shrink their balance sheets as it relates to real estate lending,” Henderson said. Larger banks cannot take up all the capacity either, nor can the commercial mortgage-backed securities market, he added.

The banks or insurance companies that typically bought the A-rated bonds in CMBS deals no longer want or need to lend in that space either. “I think that this is a unique opportunity for private credit and to get into the space to provide liquidity and to do it at a time where rates are higher, attachment points are lower, underwriting is more conservative and as a lender, I think there is excess return to be made in this environment,” Henderson said.

For DWS, the same principle of fresh opportunities in the absence of bank lenders applies to construction lending, too. Henderson said there is little construction lending happening relative to past quarters, and as a result the forward supply pipeline has diminished materially in the industrial and residential spaces.

Henderson said this dichotomy will allow private credit managers to similarly pick up where banks have pulled back and benefit later on when supply comes online into constrained markets.

Now and beyond

DWS’s US real estate portfolio currently comprises $40 billion in assets across residential, industrial, retail and office with only a small percentage of exposure in the lattermost sector. “We’ve been actively moving away from that sector for some time, which has paid off as we’ve gotten into the current market,” Henderson said.

The firm invests through comingled funds and separately managed accounts across the risk-return spectrum with its core real estate focus toward income-oriented assets that keep pace with inflation. On the non-core side, most of DWS’s investments are ground-up developments predominantly in the industrial and residential sectors.

Henderson said DWS operates typically as a low leverage investor. “But that does not mean the cost of debt does not impact what we do,” he noted. “The cost of leverage impacts the cost of equity, which impacts the overall cost of capital.”

With the Federal Reserve increasing interest rates by 500 basis points from March 2022 to May of this year, DWS has also seen the cost of capital tick upward. “As a result, we have had over the last couple of quarters a real estate recession in my view, and that real estate recession has been a capital markets recession. It has not been a profits recession,” Henderson said.

Amid that real estate downturn, Henderson said DWS is keeping focused on residential and industrial assets because of the pairing’s strong tailwinds which include leasing velocity, net operating income growth and historically low vacancy rates.

Within residential, DWS is investing in traditional multifamily but also keeping active with single-family rentals and student housing.

For SFR, the firm prefers purpose-built, highly-amenitized communities as opposed to ‘scatterplot strategies’ consisting of 100 homes in different locations throughout a given city. DWS’s student housing focus leans toward higher-end assets linked to the Power 5 conferences – including the ACC, Big Ten, Big 12, Pac-12 and SEC – within walking distances to campuses.