Even as COVID-19 continues to wreak havoc with the global economy—putting the majority of commercial real estate investment activity on pause—entities are lining up gobs of capital to pounce on distressed real estate opportunities expected to arise in the coming months.
“Billions of dollars are being plowed into new real estate funds created to buy distressed debt backed by hotels, malls, office buildings and other commercial properties suffering significant losses of value during the coronavirus crisis,” says Michael D. Underhill, chief investment officer at Capital Innovations. The global real assets investment management firm is receiving inquiries from investors across the board who are interested in co-investment opportunities in distressed assets, including institutional investors, sovereign wealth funds and family offices. “We are seeing significant pent up demand for credit investors to invest in liquid securities and hard assets, including loans and real estate, as many have been biding their time for the last several years,” says Underhill.
Private equity firms such as Blackstone, KKR and Terra Capital Partners are among those firms that have closed on or are currently raising capital for distressed funds. Apollo Global Management Inc. plans to raise up to $20 billion for distressed opportunities.
Meanwhile, Kayne Anderson raised $1.3 billion in about two weeks for a new fund targeting distressed assets. Kayne Anderson’s fundraising success certainly suggests a healthy appetite for investors who want to capitalize on distress that may arise in the current market. Part of Kayne Anderson’s fundraising success is due to its demonstrated experience in opportunistic investment strategies, notes Joe Munoz, chief investment officer at LaSalle Income & Growth Funds. In addition, the firm had demonstrated discipline in the pre-COVID environment by not deploying, or even accepting all of the capital that was available to it, Munoz says. “This behavior was noticed by L.P.s, and when Kayne Anderson let its investors know that the time is now, it was able to raise money quickly,” he says.
Blackstone also is in a strong position to capitalize on the buying opportunities emerging. In its first quarter earnings call on April 23rd, Blackstone Chairman and CEO Steve Schwarzman said the firm now has a whopping $152 billion of dry powder capital available—more than anyone else in the industry—to invest globally during the current period of historic dislocation.
“There hasn’t been a lot of change in the past 12 weeks in that the largest players were raising the most capital, and that has remained the case after the crisis erupted,” says Munoz. “Many investors are taking a wait-and-see attitude as they assess the landscape. But for those that are seeking to deploy capital, closed-end high return strategies, or risk on, is of the great interest.”
Capital targets hot spots for distress
Investment groups and private equity funds are looking at opportunities to acquire discounted loan pools, distressed assets or come in with rescue capital to secure preferential investment positions and upside participation. “Investors looking to play offense will be seeking to acquire real property at its new, lower price, or to buy debt secured by real estate from distressed lenders,” says Underhill.
It is early days, but the industry has already seen discounted loans coming to the sale market as some lenders scramble to raise capital to satisfy margin calls. For example, Ladder Capital offloaded $200 million in loans in mid-April to Madison Realty Capital to meet margin calls. In addition, Colony Credit Real Estate, Benefit Street Partners, Granite Point, Pine River and Shelter Growth Capital have all been in the market actively selling debt, according to Underhill.
In particular, capital is targeting hot spots for distress that may emerge in hard hit sectors such as hotels, retail and seniors housing. For example, hotel RevPAR collapsed overnight across the U.S. and liquidity is drying up with lenders shifting to loan forbearance and restructuring. That distress has piqued the interest of firms such as Peachtree Hotel Group, which is raising a $150 million distressed hotel opportunity fund targeting 100-key to 150-key properties, notes Underhill. The McFarlin Group also has launched a $100 million fund to acquire distressed seniors housing assets.
CMBS could be another area for potential opportunities.
According to an April 20th report from Fitch Ratings, more than 5,000 CMBS borrowers holding in excess of $100 billion in loans had reached out to master servicers inquiring about some type of relief on loan payments. Loans secured by hotel, retail, and multifamily assets represented approximately 75 percent of relief inquiries.
In addition, CMBS loans are on pace to hit a new record high for delinquencies in May or June, certainly for lodging and possibly for the CMBS market overall, notes Clancy. Trepp recorded an all-time high for CMBS delinquencies of 10.3 percent in 2012. Hotels saw the biggest spike, jumping from 1.5 percent in March to 20.8 percent in April. New delinquency data will start coming out May 11th with results for the full CMBS market in about two weeks.
Timing is everything
There are plenty of unknowns related to the depth, breadth and timing of possible distressed buying opportunities. “Most everyone believes that the true buying opportunities are still far away and perhaps even up to a year or two down the road,” says Munoz. The unique nature of the pandemic creates added challenges in being able to conduct due diligence on assets or travel to sites to view properties. In addition, there is no price discovery in this market as nothing is really transacting, he adds.
It also remains to be seen just how much of that opportunistic capital will be deployed in the current cycle, and how steeply property values may be discounted. In the last recession, Real Capital Analytics tracked over $462 billion in troubled commercial real estate assets, which was roughly equivalent to about 12.5 percent of outstanding commercial mortgage volume at that time. Property prices dropped by 35 percent nationally, which wiped out gains and prompted many borrowers to default on loans.
Although there could be some lessons learned from the last recession, this down cycle is likely to be distinctly different, partly because borrowers are holding loans with lower leverage. In addition, RCA reported in a recent market insights article that the significant amount of dry powder on the sideline waiting for buying opportunities could help to “shorten the cycle and blunt the price correction”.
So far, investors are finding disparities on pricing depending on quality of assets backing the loans. For example, debt secured by high quality assets and sponsors, whether it is first mortgages or mezzanine loans, are often only seeing mild discounts to par value, adds Underhill. “We have not heard of any transacting for less than 90 cents on the dollar,” says Underhill. The situation is much different for lower-quality or higher-risk assets. For example, banks attempting to sell loans backed by hotels, condo developments, student housing, and other troubled asset classes are having difficulty sourcing bids even at 80 cents on the dollar.
Bigger discounts are expected to emerge for distressed assets once the 90-day forbearance periods start to roll off in July and August. “We expect the next 12 to 18 months will see a surge in opportunities for distressed debt investors, as more assets require restructuring and capital infusions,” adds Underhill.
