CONTRIBUTORS
Mike Comparato
Head of Commercial Real Estate
Senior Managing Director
Benefit Street Partners
Key takeaways:
- Our 2023 white paper described an approaching hurricane that, true to our predictions, wreaked havoc on CRE and presented what we believe to be a golden opportunity to CRE debt investors. The storm’s not over, in our minds. But the opportunity set in CRE debt remains.
- As we said in our original piece, property values declined, especially in the office sector. Banks continued to pull back on CRE loans, and others stepped in to the fill the void. And, a wide swath of CRE debt investors posted robust returns.
- We continue to believe that CRE debt is a more compelling option when compared to CRE equity, barring a rapid decline in interest rates, which we do not expect to see. In fact, after multiple years of CRE investors hoping for lower rates, it may be time to realize that the macro conditions that could cause rates to fall quickly would likely be devastating.
- We weren’t perfect. “Extend and pretend” has gone on longer than we imagined, and banks have held up better than we thought. But were our predictions wrong, or just early? We think the back half of the storm will likely prove us right.
- As in many other areas of the economy, uncertainty reigns across the CRE universe as we look ahead. Nonetheless, we stand by most everything we said in 2023. We’ll look at what’s next in the space and offer some hints on how opportunistic investors can position themselves for the longer haul.
In this paper, we’ll take a look back at what we said in 2023, how things worked out, what we got right and what we got wrong—though we argue that those takes are more about timing than accuracy. We’ll also discuss where things stand, the robust opportunity set that remains, and what to expect after the storm moves on for real.
Conclusion
Two years ago, all of our forecasting models were aligned, making our hurricane prediction a fairly easy call. Today, there’s more uncertainty. These days, it’s a bit more like wondering where the storm will track, where it will hit, and how much damage it will do. We don’t know whether the back half of the storm will be mild or disastrous, but it’s coming, with another wave of stress. In our minds, there’s no avoiding it.
And that’s perfectly fine. Corrections are a reality, and they are healthy. They can be painful, but also therapeutic. Markets do not function well without losses, and capitalism does not work without consequences, and whatever pain we do feel will be matched by a robust opportunity set.
As for the eye of the storm, enjoy it while it lasts. The first part of the hurricane damaged the equity portion of the capital stack, completely wiping it out in some cases. The back half of the storm will hit credit. Banks, LifeCos, debt funds and mortgage REITs will eventually mark their books to market, and there will be losses.
We view the order of magnitude as fairly easy to call: It will be worst in the office sector, which will combine with 1980s-and-older vintage, class B and C multifamily assets in secondary and tertiary markets to make up the majority of the pain. The balance of the multifamily market could well be next, followed by industrial/logistics, then retail and hospitality.
Still, the environment will continue to offer some of the best risk-adjusted returns CRE debt investors have seen in decades. The winners, in our view, will be disciplined and nimble. They will be selective, with a defensive mindset, but they will be ready to jump in when the time and the opportunity is right. Portfolio positioning will be a key. Meanwhile, choosing the right partner may be the most important decision any investor makes—regardless of where things stand in the market cycle.
WHAT ARE THE RISKS?
Past performance does not guarantee future results. All investments involve risks, including possible loss of principal.
Risks of investing in real estate investments include but are not limited to fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by local, state, national or international economic conditions. Such conditions may be impacted by the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, and environmental laws. Furthermore, investments in real estate are also impacted by market disruptions caused by regional concerns, political upheaval, sovereign debt crises, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Investments in real estate related securities, such as asset-backed or mortgage-backed securities are subject to prepayment and extension risks.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Equity securities are subject to price fluctuation and possible loss of principal.
An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor’s ability to dispose of them at a favorable time or price.
Diversification does not guarantee a profit or protect against a loss.
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