Rising interest rates and continued market uncertainty are causing traditional lenders to pull out of the market. For Invesco Real Estate, that means an opportunity to do more debt deals.
“CMBS is essentially off the table. Banks are moving slower and more cautiously,” says Bert Crouch, head of North America at Invesco Real Estate. Meanwhile, although some insurance companies had a very active first quarter, with loan volume up over 80 percent year-over-year, those firms are now expected to pull back in the coming months, having already put a lot of capital to work this year.
“Lenders will be more selective and more conservative, which provides for limited lending options and gaps in proceeds needed to refinance existing loans,” he says.
Mortgage credit spreads have climbed by over 100 basis points in the last year, per data from both Freddie Mac and the Federal Reserve. Assets are repricing between 5 percent and 15 percent, Crouch says. The Secured Overnight Financing Rate, the US replacement for LIBOR, is currently at 2.28 percent and set to be around 3.25 percent by year end, according to Crouch and data from the Federal Reserve. The 10-year Treasury yield is on a downward trajectory too, having been as high as 3.49 percent in June and now sitting at 2.67 percent. Meanwhile, the higher risk premia is driving up debt returns.
“We see those spreads widening, and so the IRRs keep ticking up,” Crouch says. “They were closer to 8 [percent] six months ago. Now they’re at least 11 [percent] when incorporating the forward curve.”
However, Invesco is comfortable taking on higher risk in debt because it is still lower risk than investing in equity. With debt investments, being further down in the capital stack creates a cushion against equity risk but still generates returns in the low double digits. Beginning at the end of the first quarter, Invesco Real Estate began incorporating credit investments into some of its equity strategies because of heightened investor demand plus the compelling relative value, Crouch says.
Last year, the firm invested around $11 billion in new transactions in North America, around $4.2 billion of which was in loans. Globally, the firm’s AUM managed on behalf of clients is $92 billion, $5.2 billion of which is debt. Crouch expects Invesco Real Estate’s credit investment activity to pick up further during the second half of the year: “If you look at where debt transaction volume will be in the second half of the year, it will be very significant relative to even last year.”
The firm believes it can turn up the volume on the amount and types of loans it can originate this year because of the scale of its real estate debt portfolio combined with its existing lending relationships.
Approach to risk
If Invesco Real Estate wanted to launch a credit strategy today, even if the firm hired the best credit professional, it would not be successful without the strong relationships and track record it already has in the strategy, he notes. “To go replicate that, I wouldn’t be able to do it. The fact we already have it in-house is paramount to our ability to move quickly and take full advantage of the market opportunity in real time.”
Invesco Real Estate is comfortable investing in debt despite the higher risk because it will not lend on properties where it would not want to own the equity. For example, the firm is lending on residential and industrial assets, but it generally avoids debt originations in office and retail. Invesco Real Estate’s approximately $50 billion in assets under management in North America allows the business to analyze rents, occupancy levels and other data sets internally, meaning Crouch and his team feel they have an accurate view of the market despite the uncertainty.
“We feel very comfortable that we have a good feel for where values, by property sector and region, are today and where they’re going,” Crouch says. “As long as we continue to maintain our credit discipline, we don’t feel we are taking materially more risk today despite the income returns being up significantly since the beginning of the year.”