A growing number of commercial real estate executives are looking past this year for a possible recovery in the US investment sales and lending markets, as more think 2024 could bring a meaningful return to transaction activity.
Prior to the failures of Silicon Valley Bank and Signature Bank in the US, and Credit Suisse’s acquisition by UBS, there was a strong sense that the first half of 2023 would be slow, with activity picking up in the second half. But this perception started to fade earlier this month at MIPIM, the global real estate conference held in Cannes in mid-March.
Riaz Cassum, an executive managing director of capital markets at advisory JLL, was one of many market participants who spoke with Real Estate Capital USA that raised the idea of a longer time horizon for the resumption of transaction activity.
“The year ended looking like 2023 was going to be two quarters of continued tightening by the Federal Reserve and a pick-up in transaction activity toward the third quarter,” Cassum said. “The period after the bank failures in the US created a new dynamic – not that we needed more drama.”
The year of asset management
More lenders and investors will be focusing inward, managing existing debt and equity portfolios, and trying to stave off problems around maturities, said Antonio de Laurentiis, global head of private debt at Paris-based manager AXA IM Alts.
“We believe asset management will be a pivotal theme this year as lenders look to protect their books, look to protect their exposures, and speak with borrowers and help them get through refinancings,” de Laurentiis said. “We slowed down our investment pace last summer because we thought pricing was too tight and aggressive for us bearing in mind our ultimate investors are pension funds and insurance companies, and relative value is key in the decision process.”
The US and global commercial real estate markets are facing record maturities over the next two years, with key metrics that include CRED iQ’s estimate of a $25 billion maturity wall for debt on US multifamily properties. Other key metrics include $270 billion of commercial mortgages held by banks that are slated for maturity this year, according to data from New York analytics provider Trepp.
With the Federal Reserve’s 25-basis point increase in its target rate on March 22, the Federal Funds rate is now in a range of 4.75-5 percent. One year ago, the Federal Funds rate was at 0.25-0.50 percent.
A key problem with sponsors’ ability to refinance debt comes from both the increase in interest rates as well as the fluctuations in spreads. Apart from a two-week period of stability in February, this volatility has made it difficult for lenders and borrowers to move ahead on new financings.
“Even as base rates were going up, we were starting to see corporate and mortgage spreads coming in,” Cassum said. “We saw peak borrowing costs and how they affected cap rates and values and we also saw rates coming down and spreads coming in as inflation got more under control. But after that, there was more negative news on the inflation front and that period of stability disappeared.”
Duco Mook, head of treasury and debt financing for the EMEA region at CBRE Investment Management, says there is potential for the bid-ask spread to narrow between buyers and sellers in mid-May or early June. But the key to getting deals done is more about having a stable market.
“People are talking about high rates but it is not the high rates that make your life difficult – it is volatility,” Mook said. “We need to know where rates are and then we can adapt to certain events.”
Bank failure fallout
While it is too early to determine the long-term fallout from the bank failures in the US, there was a strong sense that the Federal Reserve had moved quickly to ringfence the situation. Additionally, its decision to increase rates by 25bps earlier this month was seen as a positive.
“[Prior to the bank failures], the expectation was that the Federal Funds rate would go to 5, 5.25 or even 6 percent,” Cassum said. “There is now a feeling the Federal Reserve will be somewhat cautious on pushing the economy into a ditch. That could help borrowing costs to come down.”
Base interest rates are coming down because investors are moving into safe investments like Treasury securities. “But spreads are widening out because of concerns about risk,” Cassum said. “We could see a reduction in the cost of debt that could stabilize the decline in values, most of which have been driven by rising rates and most of it has been marked to market on paper.”
There is a growing consensus that now is one of the best times to be a lender, which has convinced a number of equity investors to get into the debt space or has led existing debt investors to expand their platforms.
de Laurentiis sees a rare opportunity for alternative lenders to increase their market share as banks withdraw from the market due to concerns about the impact a highly anticipated correction to commercial real estate values will have on their lending books.
“This is an interesting entry point for alternative lenders,” de Laurentiis said. “Today, flexibility on capital allocation in terms of risk appetite, timing of deployment, geographies and asset classes is even more relevant. We have the power to deploy capital, but it is all a question of timing, the ability to be flexible in the allocation and relative value assessment.”
“If I don’t know how to value something, I’d rather have a cushion and be a lender right now,” Cassum said. “Rates are high and, on a risk-adjusted basis, you can get good yields as a senior lender or a lender that provides preferred equity or mezzanine debt. No one wants to be in the common equity position at a time when values are falling.”
de Laurentiis also identified execution risk as a key concern, even as lenders and borrowers try to get deals done. “If you were to have done a $200 million deal 18 months ago, a single bank could have underwritten and syndicated that loan. Now, you need two or three banks to put that deal together,” he said. “Thus, creating opportunities for large alternative lenders with real estate expertise that can grant execution capacity.”