This article is sponsored by Invesco Real Estate.
How was the US lending market affected by inflation and rising interest rates throughout 2022?
As we look back at 2022, it was really two years in one. The second half of the year was characterized by a true paradigm shift in the investable universe. We are now in a rising rate environment, which we anticipate will result in a sustained elevated rate environment for the foreseeable future.
We work really hard to be the steady hand in the market for our relationship borrowers and have been pretty successful doing so, but behind the scenes the rate environment has changed our business in many ways. We have seen the return profile of real estate loans increase quite substantially since the beginning of 2022. We also have seen the rising interest rate environment result in a slowdown of deal volume through the second half of 2022 as our relationship borrowers have slowed down their acquisitions pace. We anticipate there is going to be a great deal of pent-up demand for real estate debt once the market has clarity on the ultimate terminal interest rate and valuations.
How have lending terms evolved, especially when it comes to pricing, LTV and beyond?
The starting point matters and the industry started from a point of relatively healthy credit standards. As we have entered 2023, there’s been some normalization in lending terms relative to the second half of 2022. Credit spreads have moved in since the beginning of the year as the market has started to anticipate the Federal Reserve’s rate hike cycle pausing later this year. And we have also seen some appurtenant loosening of credit standards, though not back to pre-June 2022 levels.
What are the opportunities and imminent headwinds affecting the sector today?
Today, we are seeing banks pull back fairly substantially from real estate lending at the same time as real estate debt funds and alternative lenders see increased fundraising activity and relatively healthy liquidity positions. In the interim period before the market truly stabilizes, there is an opportunity to originate high-quality real estate bridge loans at materially elevated pricing relative to the pre-pandemic period.
We have come out of a period of significant convergence in returns and yield expectations across property types, asset classes and geographies. And now we are seeing much more divergence. So we still see very healthy overall fundamentals for those asset classes around which we have secular convictions, specifically multifamily, single family for rent, industrial and specialty product types including life sciences. In contrast, the office market has only become more challenged. We are anticipating that existing legacy loans on office will continue to face some headwinds and experience elevated defaults and loss rates.
What are the challenges alternative lenders are looking at for the future of the US CRE market?
Just as we have seen a divergence in property type and market-level performance, we are going to see real divergence in terms of alternative lenders. We would anticipate that you would continue to see fairly healthy growth of lenders focused in the core-plus or light transitional space as a result of healthy liquidity levels and strong performance in their existing portfolios.
There are alternative lenders who will likely have a more challenging path during the immediate and near-term future as a result of overexposure to the more challenged asset classes and potentially some liquidity issues arising out of reliance on securitization exits on their loans. We view that adversity as opportunity, and I would expect that there would be some consolidation within the real estate debt fund space over the next couple of years and anticipate that we will be a beneficiary of that.
How does real estate credit fit into an LP’s portfolio allocation plan?
Real estate debt offers three key potential attributes to investors: elevated current income, downside mitigation in periods of volatility and an inflation hedge in a rising rate environment, specifically for floating rate real estate debt strategies. We are seeing increased interest for credit allocations at this time, as a result of that defensive positioning and the downside mitigation in a period of time when there’s more uncertainty around values.
From a long-term perspective, real estate debt is designed to perform throughout market cycles with less volatility than real estate equity investments and a total return profile similar to core real estate equity. We are seeing LPs really take another look at real estate debt allocations in this moment in time for that very reason.
Where is Invesco looking for new and expanded CRE debt opportunities now?
Invesco Real Estate has continued to expand its real estate debt product offering since we relaunched the business in 2013. The foundation of that business is our core-plus lending program in the US, where we are a light transitional bridge lender focused on high-quality, institutional real estate and institutional borrowers. Since 2020, we have offered a similar program in Europe. We have built an eight-person team in London to service the same borrower relationships that we work with here in the US.
In the US specifically, we look at private real estate debt as a $5 trillion asset class with expected maturities north of $500 billion in each of the next five years and anticipate that there will be substantial opportunity for groups like ourselves to continue to grow our market share. We are actively pursuing preferred equity opportunities to provide gap financing and are endeavoring to be able to more effectively address the middle market in addition to our historical focus on the institutional segment of the real estate market.
What does innovation look like within Invesco’s CRE debt strategy now?
We have engaged with our data science team to develop an internal proprietary probability of default model, which we are using in the evaluation of each and every new loan opportunity and as an ongoing portfolio risk monitoring tool. We also have invested in asset management technology infrastructure to allow us to have better access to information in our portfolio. And we have substantially built out our asset management team, all of which is intended to allow our relationship managers to spend more time with their clients.
We have been very much on the forefront of thinking about how diversity results in better investment outcomes and we are proud to say that the majority of our team comes from diverse backgrounds. As a result, we built a team that looks and thinks a little bit differently than lenders of the past.
What role is ESG integration playing in Invesco’s CRE debt strategy?
We integrate ESG into our risk analysis and pricing models. We are actively evaluating opportunities of environmental, climate and the associated economic risks by sub-market and in micro-market locations. Examples would be assessing the potential for increased insurance costs in the future or costs associated with regulatory requirements to improve environmental performance and ensuring that is being incorporated in our underwriting. This approach helps us get better economic terms from our lenders.