Reven Office REIT, which last week opened its doors to offer financing for well-located, high-quality office properties, sees a significant advantage in being a first mover in a market in which institutional capital has all but dried up.
The company, based in La Jolla, California, was formed by veteran real estate lenders and investors Ethan Penner and Chad Carpenter, who are hoping to raise $1 billion for the strategy. In addition to lining up a lead investor to provide roughly $100 million of capital, the firm intends to complete an initial public offering and use proceeds to make strategic investments in distressed office debt and acquired properties at significant discounts.
“The office sector is the hardest hit of all asset classes, mainly due to the shift in demand from flexible working and work from home,” Carpenter said. “If you tie in the headwinds that include higher interest rates and cap rates, higher expenses and capex, lower rental rates and higher vacancies, it is like every headwind is going against offices at the same time. It has been devastating and it is just crushing values.”
While the firm will have the ability to provide some rescue capital or make structured real estate investments, Carpenter said the bulk of the firm’s activity will be geared toward acquisition loans to finance sponsors which have acquired properties at a low basis. “We are looking to provide fresh capital to kickstart the business at a much lower basis and with new investors,” he added.
Prelude to launch
The plan for Reven Office REIT stemmed from experiences Carpenter has had over the past year in trying to acquire office properties at discounted prices. Carpenter, who was chairman and chief executive of Reven Housing REIT and the founder and chief executive of office-focused investment company Equastone, considered launching a closed-end equity fund to buy office properties because of the dire situation in the sector.
But when bidding on office deals, Carpenter found his bids were always the lowest – a factor which stemmed from his belief that the sector’s downturn is the worst he has seen in his career.
“It made me very conservative in my underwriting,” Carpenter said. “I realized I wasn’t going to get any actionable deals, but I also realized there were no office lenders right now and that market was locked up.”
This understanding led Carpenter to launch the firm with Penner, who led the real estate finance and securitization business at Nomura Securities in the 1990s. Penner also founded CBRE Capital Partners, a commercial real estate investment management platform, and launched construction lender Mosaic Real Estate Investors, which was later acquired by Ready Capital.
“When a sector goes dark, capital flees and institutional capital has always been very poor at discerning the difference between the babies and the bathwater,” Penner said. “If they decide the sector bad, then that sector gets no allocation and goes from hot to cold to off very quickly. When it goes to off, it can become attractive because there are always babies thrown out with bathwater and entrepreneurs understand that.”
He continued: “While there may be significant obsolescence the sector is facing, with no capital chasing it, you don’t have to focus on the segment that is facing that risk. You have a unique, non-competitive environment that allows you to focus on the elite segment of the sector that has been thrown out with the bathwater.”
Defining the opportunity set
Carpenter, citing data from data and analytics provider CommercialEdge, noted that total office debt across the US stood at $920 billion as of October 2023.
“Nearly $150 billion of mortgages on US office buildings are maturing by the end of 2024, and just over $300 billion of loans will mature by the end of 2026, which presents a sizable opportunity for well-capitalized debt platforms,” Carpenter added.
But Reven Office REIT has strict parameters for what it will consider, Carpenter said.
“We talk about viable buildings, which means the highest quality buildings in the best locations with lots of amenities and experienced sponsors,” Carpenter said. “We need experienced operators and borrowers who have been through a downturn and are underwriting realistic assumptions. Capex costs will be a lot more, rental rates will be lower and cap rates will be higher on exit.”
Penner noted that historically, sponsors have somewhat underestimated the operational challenges of operating offices, which includes budgeting for costs like re-tenanting expenses.
“For most of my career, the investment community has been very afraid of hotels and nursing homes because these properties are more like operating companies and less like what one would think about real estate, which is essentially a rent-collecting business,” Penner said. “Offices are at least as operationally intensive as hotels in many ways and with risks that can be even larger from an operational standpoint.”
Carpenter noted the process through which the firm underwrites and values buildings has changed significantly during the current period. In the 1990s, for example, it was possible to acquire buildings at discounts to replacement costs.
“Today, you can’t do that. Some of these buildings are economically or functionally obsolete because the carrying cost or the cost to reposition just doesn’t make sense,” Carpenter said.
The firm will work closely with its existing contacts in the industry, including the leasing and mortgage brokers, which Carpenter underscored play a critical role in the sector. It will also seek to work with experienced sponsors who have cash-flowing assets.
Ultimately, the firm will be solving for a level of dislocation in the market that is similar to what real estate went through in the 1990s, Penner said.
“Real estate is an industry of entrepreneurs and if you can be an entrepreneurial lending partner, you have a huge leg up when compared to bigger, more bureaucratic entities. For a developer to be able to negotiate directly with me or Chad, it will be a much more efficient experience,” Penner said
The firm aims to earn equity-like returns on its investments and will not seek any kind of speculative investment.
“There are people circling the wagons for returns in the 20s or 30s or more who will be taking all kinds of risks. We are looking for safe and predictable cash flow streams,” Penner said. “We are not looking for lease-up risk or turnaround markets or conversions or dreams. A lot of real estate operators and investors have dreams and we are not financing dreams. We are financing in-place cash flow.”