RXR’s Rechler flags concerns on commercial real estate credit risks

REIT chief executive predicts more distress, refinancing creativity and preferred equity use.

Scott Rechler, chief executive officer and chairman at New York-based real estate investment trust RXR Realty, is concerned about what he sees as looming credit risks present in the commercial real estate market.

Rechler said during his March 29 keynote at Goodwin and Columbia Business School’s 2023 Real Estate Capital Markets Conference that the lending market needs to prepare for more distress as interest rates remain elevated. In turn, this creates new refinancing opportunities and use cases for preferred equity.

RXR is tapping into its own preferred equity opportunities in line with Rechler’s outlook.

The firm is working on four different preferred equity investments totaling about $250 million in New York City. The money will be used to help lease buildings, facilitate upgrades and add amenities that tenants may want or demand. “I think it’s an opportunity for those that want to look through the noise,” he said.

Two coinciding areas of near-term concern for Rechler are the fallout from the recent regional banking crisis and the impact of higher rates on property valuations.

The collapse of Silicon Valley Bank and Signature Bank, as well as the troubles at First Republic Bank, were crises brought on by duration mismatch issues, Rechler said. “People were borrowing short term and investing long term and then there was that mismatch along the way.” 

Rechler likened the SVB and Signature struggles to the Savings & Loan Crisis of the 1980s, which eventually saw an estimated 3,000 banks and thrifts either fold or get bailed out by the US government.

The now-pressing duration risk considerations apply to about 4,000 regional and local banks. For Rechler, the credit risk that has yet to materialize ranks as the more important driver for market challenges during the next few years.

“We have to re-value everything for that,” he said. “And that’s why we have not yet really dealt with revenue, the banks or the challenges that are out there, the credit risk of that revaluation and how many loans are underwater [and] which equity has to be written off as part of that.”

On asset valuations, Rechler said the more normalized interest rate environment will require a widespread reevaluation across the commercial real estate market.

“That’s a pretty painful process because people have to then recognize what they once owned that was worth ‘X’ is worth a percentage of ‘X’ – whether that’s the equity or the debt – and there’s a whole restructuring process around that,” he said.

Cracks in the market right now are not necessarily linked to the quality of assets, Rechler said, but rather the capital structures behind the assets. “You’re seeing institutional-quality buildings with institutional owners deciding that based on that capital structure, they don’t want to throw good money after bad.”

Lack of transparency around value and a lack of market price discovery is further clouding investment decisions for owners and lenders. This void is opening the door for more gap financing to buy time, be it in the form of using preferred equity or other bridge lending measures.