How PGIM is calibrating against choppiness

'There's a reset in the real estate markets,' says Lee Menifee, head of Americas.

PGIM Real Estate is dialing up its focus for the second half of 2022 on multifamily and alternative lending opportunities in order to weather choppy market conditions brought on by inflation, continual interest rate hikes and looming recessionary conditions.

Lee Menifee, head of Americas investment research at the Madison, New Jersey-based manager, says the current lending environment is more interesting and challenging than in prior quarters as macro headwinds taper lender activity.

“We know that the investment environment has changed from both a debt and equity perspective, and it has changed very quickly – just in the last six months – and we know that there’s a reset in real estate markets,” Menifee says. “What we’re really emphasizing here is we don’t know what the next six months or 12 months are going to bring.”

The firm has concerns about asset values across the spectrum, with PGIM digging into the topic in its most recent global outlook to better identify structural trends.

“I think of this year’s global outlook as being very little about what to do because of what’s going to happen in the next six months and much more about what’s going to happen in the next six to 10 years,” Menifee says. “So, we know it is a tricky environment to deploy capital.”

Lay of the land

Like other lenders, PGIM is maintaining conviction around the residential market.

“With interest rates and borrowing costs now above yields in a lot of the housing markets and multifamily markets, that obviously changes the equation for a lot of investors,” Menifee says. “And what we’ve seen is the exit of, or at least a pause [among], a lot of the highly leveraged buyers who are manufacturing higher-than-core returns via the use of leverage, and leverage is no longer accretive.”

Looking at PGIM’s transactions and the broader landscape, Menifee says the firm has seen the debtor pool thin because of the reduced amount and frequency of highly levered buyers participating in transactions. Deals now take a little longer to get done, which he says indicates a healthier market than iterations prior. “It’s marginally better to be a buyer than a seller as compared to then.”

Menifee says that, while the rise in rates has garnered the most press, what is not getting much coverage comparatively is the reduction in proceeds attainable now. “That’s changing the landscape as well, because buyers are looking for highly leveraged loans,” he says. “We have seen lenders be much more cautious about their loan-to-value ratios and that has been true across really all sources of lending.”

The reticence from lenders has a twofold effect for PGIM. Menifee says the lending environment is better now for senior lenders amid higher rates. Meanwhile, to the extent that loan issuers don’t need to offer exceedingly high loan-to-value terms, risk-adjusted returns are better despite tightened spreads.

“The other part is, that opens up even more of the gap in financing between where the equity and the senior debt is,” he says, noting such gaps have widened substantially. “And while there are providers of that capital, not all those providers have that capital or are themselves as well capitalized as they should be, some of them also rely on borrowers.”

Menifee says to the extent there is an opportunity in the gap financing realm, conditions now are better than a year ago, and it is more interesting for PGIM to participate in preferred equity or mezzanine deals because the risk-adjusted returns line up with the firm’s standards.