Sabal Investment Holdings is seeing a rise in transactions through which the real estate investment management company can co-originate loans with banks.
The firm based in Irvine, California, has completed three deals of this kind in the past few weeks, including the origination of a $64.5 million loan to finance the conversion of the LaGuardia Plaza Hotel, and expects to do more as banks take harder looks at their balance sheets, said Pat Jackson, chief executive.
Sabal completed the financing on the 353-room property at 10404 Ditmars Boulevard in Queens, New York, with Bsafal and Argo Real Estate. Synergy Hospitality Group, based in Wayne, Pennsylvania, was the sponsor.
“In that transaction, we were part of the solution for a bank to do some balance sheet work,” Jackson added. “The hotel is part of a maturing loan refi, and we are coming in with new capital, a new structure and a refi that matches where valuations are today, not where they were.”
Jackson believes banks this year will need to start resolving troubled loans and reduce their commercial real estate exposures.
“The number of banks with substantial concentrations of real estate on their balance sheets relative to their capital is shockingly large. That will have to start to be realized and resolved,” Jackson added. “We are doing deals on a one-off basis and are also starting to see portfolios come to us.”
While the failures of Silicon Valley Bank and Signature Bank raised expectations of distress, the fallout for commercial real estate was not immediate, Jackson said. This was, in part, because the failures were not real estate related.
“We believe that through 2024 and 2025 there will be a shift with true valuations starting to hit through. Banks will start taking their medicine and the regulators will be a lot more rigorous in scrutinizing the balance sheets of banks at the loan level. Naturally, that will result in more distressed transactions occurring on a go-forward basis,” Jackson said.
He continued: “When covid hit, we thought there would be a return to a distressed market. Initially, we saw one-off deals that needed rescuing of some sort, but we didn’t see a broad reset where banks had to broadly write down their books or see distress on a macro level.”
The firm has been fielding more calls from banks seeking creative solutions.
“With our history in the banking sector, many banks are coming to us directly and saying, ‘I have loans I need to move off my balance sheet. I can’t foreclose so can we figure out a way for you to take over and move it to the final steps?’” Jackson said. “We can often structure something with a bank that works for everyone. Rather than just saying, ‘Here is my price, take it or leave it,’ we are hoping to find a solution that works for us and for them. In other words, this is not a zero-sum game.”
Stress on the horizon
A January report from New York-based data and analytics provider MSCI tracked a rise in distress in 2023. The firm reported a balance of $85.8 billion of troubled loans at the end of 2023, an increase of $28.9 billion over the year. MSCI also is reporting another $234 billion of potential distress.
The stress being seen is largely being caused by the increase of more than 500 basis points in interest rates over the past two years, Jackson said.
“As long as rates were low, a sponsor with sub-performing assets could say, ‘Let’s hold our breath and maybe things will get better.’ It was a hope strategy,” Jackson said. “But when interest rates went up, it forced a final realization that for some troubled assets with borrowers on the edge, rates had taken them over the abyss.”
Jackson believes the coming year will be about tackling this distress, noting it is necessary for the market to recover. “As painful as the global financial crisis was, it had to happen,” he added.
The firm is seeking mid-market opportunities, looking for deals in the $20 million-$60 million range. “We fill a void that we are bigger than friends and family, as well as regional funds, but we are not so big that we can’t be nimble and pursue single opportunities,” he added.
Jackson, like many of his peers, is starting to see a rise in transaction activity on the debt and equity side. This will be spurred in part by the amount of dry powder on the sidelines as well as a decline in interest rates.
“The reality is that we are at a breaking point and the writing on the wall,” Jackson said. “Things are not going to get worse in terms of carry cost and could even get better, which will help the lending market and the capital markets. If you have an investment thesis and capital solution to make that work, you can come up with a price and a business plan.”
By sector, Jackson continues to see stress in the multifamily and office sectors. In the office sector, Sabal is starting to see a bottom.
“We can now look at assets and figure out a number based on the cost of capital,” Jackson said. “On a macro basis, everyone is beating up office and it has some real challenges. But we do see some opportunity, and have invested in office buildings recently in New York and Seattle. If you can see beyond the doom and gloom and make the right bet, there is often a structure that will work.”
Deals completed in the past two to three years are suffering from the impact of maturing short-term debt which will need to be refinanced into a higher-rate market.
“The regional and community banks that leaned in to make value-added bridge loans on commercial real estate are now seriously overweighted to these properties,” Jackson said. “That needs resolving. Those assets will have to come to market and be reset to a new basis.”
He continued: “Higher interest rates sucked out a lot of the excess cash that the original borrowers maybe had to weather through it. Banks are then saying, ‘I can’t extend again, you have to find a solution’ and the borrowers are saying, ‘I have to make a decision, but I don’t have money because I’ve been defending this asset for so long.’ Those chickens are coming to roost.”
A key to investing in a market like this is a long-term perspective, Jackson added.
“And if you can find a path to be able to rescue an asset, you can probably do well if you have a longer horizon and the right starting basis,” he said.