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Who's Acquiring Assets Today?
What’s the Latest Pulse on the Debt Market?
How Liquid is the Debt Market?
Are You Seeing a Predominance of Seller Financing?
Are You Seeing Buyers Accept Negative Leverage Today?
How Are Your Clients De-risking?
What Property Sectors Do You See as Bright Spots?
Are You Seeing Buyers Accept Negative Leverage Today?
Some negative leverage is accepted in higher-growth multifamily/industrial markets, but if so, it’s not much more than 25-50 basis points (bps), with a relatively quick path to getting to positive leverage (whether through low Weighted Average Lease Term (WALT) or management/expense control etc.). That may be drying up thanks to the supply pipeline (at least in the multifamily space) in these markets.
Yes, but much less so today than a year ago. While fundamentals and rent growth are surprisingly strong, forward-looking assumptions have grown more realistic (i.e., moderate trended rent growth), causing investors to retreat to safety and surety of income for debt service coverage.
Stabilizing messaging from the Fed on the path of monetary policy is providing a better runway for much needed alignment between buyers, sellers and lenders. As a result, we’re starting to see gradual signs of momentum, particularly from buyers that are eager to take advantage of this period of relatively less competition (before capital markets conditions unlock more significantly and the proverbial window of opportunity has closed).
Private buyers with on-the-ground expertise and fewer liquidity-related challenges are taking more space in this marketplace right now.
Who’s Acquiring Assets Today?
It would be a misnomer to say that debt liquidity is lost or that debt liquidity is the root factor constraining market CRE capital markets momentum. We are dealing with a cost-of-capital “issue” or adjustment process, alongside a divide between buyer and seller acknowledgement of the upward adjustment in longer-term required yields. We're still tracking over $413 billion in new debt originations in the core sectors that closed in 2023 (and that figure will get revised upward as new loans come in for Q4 throughout the data collection period in Q1). While down 50% versus the feverish peak year in 2021, the figure is only 37% below more normalized years of 2017-2019. Debt is there, it is just selective and expensive relative to where pricing and going-in yields are. The valuation (sell) side needs to adjust to make this work. The rest of the liquidity story really gets to the essence of selectivity and caution. Liquidity for institutional-quality product, preferred sectors and sponsors is there, but of course remains cautious and pricey.
Banks are facing several challenges beyond just CRE on their balance sheets as highlighted by the held-to-maturity (HTM) issues that caused SVB to go under, and we don’t expect a significant change in their ability to increase net new originations in 2024 (as the yield curve un-inverts, conditions will start to improve). Yet, outside of the money center banks, there’s a lot of liquidity from private debt fund sources. We’ve also seen strong appetite from life insurers on the back of their annual allocations.
How Liquid is the Debt Market?
There is currently ~$42B in dry powder for private credit strategies looking for equity-like returns with debt-like risks. The cost of this capital is extremely expensive, but there has been some spread compression, and spreads are trending along historic norms. Keep in mind that some of this private capital is also tied to warehouse loans from banks, which may also be constraining the ability to deploy dry powder right now.
On the multifamily side, agencies still have plenty of liquidity and are willing to lend even if they’re focused more on their affordable mandate.
High Net Worth (HNW) individuals and family offices are also active, given the longer-term and relative focus on the basis-plays that can be had in the market today.
Some also indicate that there’s liquidity and interest from owner-users, while others are mentioning pockets of foreign buyers showing interest in price-per-pound deals in markets that were previously too rich from a pricing point-of-view.
Base rates have shifted structurally higher towards a more normalized level following the Fed’s restrictive monetary policies aimed to combat inflation, but the 10Y has come in a bit since fall 2023. Credit spreads have also tightened as market volatility has eased and financial conditions have loosened following the Fed’s dovish shift in messaging back in December. We’ve also seen a noteworthy contraction in CMBS debt spreads, which has helped create some much-needed momentum and greater diversity in debt sources. This modest tightening in both base rates and in CRE credit spreads has provided market participants with marginally better debt conditions and has helped grease-the-wheels of activity.
Despite the headwind in structurally higher cost of capital, fundamentals outside of office are surprisingly strong. We’re facing a situation where we have resilient and robust fundamentals alongside constrained debt market liquidity (where there is significant pressure on capital stacks and deal viability). The more that lenders start loosening up conditions and sellers grow conditioned to the fact that we are in a structurally higher cost of capital environment, the more that the bid-ask spread will narrow, allowing new deals to pencil at prevailing debt costs.
What's the Latest Pulse on the Debt Market?
Investors have been utilizing shorter- to medium-term fixed rate debt structures (i.e., three and five year terms) with the intention to refinance in a few years once the Fed starts its cutting cycle.
Anecdotally, it’s something everyone is talking about. But the prevalence is relatively muted from a scale standpoint. Real Capital Analytics (RCA) tracks seller-financed deals and still only cites about 2% of deals closing with seller financing (up from basically 0% in 2022).
There’s no guarantee that offering seller financing will get the deal done, but it certainly helps move the needle. Conviction throughout the market is still fickle and tenuous right now though, and buyers still need to have strong conviction in the deal.
The fact remains that investor psychology remains on precarious footing. Where deals strike at initial contract will not necessarily be where they end—there’s a fair amount of instability in deal calculus right now.
Loan assumptions are more popular today than they used to be, for obvious reasons. The challenge is getting the loan-to-value loans (LTVs) to a reasonable place, as well as the remaining term that makes the deal still attractive. You may be able to get to a 40% LTV, but then you have to add on still- expensive mezz or pref on top of that, meaning your total cost of capital may end up mirroring new debt.
Are You Seeing a Predominance of Seller Financing?
Private credit has been the “strategy de jour” for many players and it can often be part of a selling agreement as well. The seller may need/want to recycle capital into other deals or need capital to meet redemption queues, but they may want some exposure at a lower risk level to the asset as well.
The risk-off playbook is quite predictable. Selectivity remains the name of the game—investors/lenders are generally making smaller investments across a relatively diverse geographic spectrum to mitigate concentration risk. Many will aim to wait for the bottom and buy below replacement cost. While others are seeking to move higher up the quality-chain, taking a more defensive, selective stance toward the entire profile and scope of the deal. Regardless of risk/return profile, investors across the spectrum are looking at everything through a more critical lens.
We’re entering an income-oriented era, and investors must now focus on finding operational alpha, driving operational improvements and aiming to generate high enough income returns to ensure that returns can hold up in the long run, regardless of where exit caps land.
Others are focusing on rebalancing their exposures and diversifying into more attractive sectors. Those with relatively higher exposure to office will be looking to shed assets that have limited upside (i.e., mid-low quality commodity office), whether by handing keys back or taking to market.
How Are Your Clients De-risking?
You can’t deny NOI projects and income-return prospects in the chapter ahead.
Among the main categories of office, industrial, multifamily and retail, industrial solidly surpasses the other sectors from an income-growth standpoint.
Retail, or more specifically neighborhood retail, has also been resilient. Very little retail has been built since the GFC, which is keeping fundamentals in relatively good shape. The health of the consumer is really the determining factor for the outlook—which looks good today, but may change in the face of a recession.
In multifamily, a sizable supply wave in the near-term will soften fundamentals, but the longer-term tailwinds are still undeniable (affordability constraints throughout single-family market, demographics, etc.).
The niche/alternative sectors continue to draw investor attention from a differentiated beta perspective. They offer counter-cyclicality or less sensitivity to the economic cycle (i.e., data centers, senior housing, medical office, etc.). They are also less mature from a capital flow standpoint, which offers an opportunity to get in, acquire a nice portfolio and eventually sell to the larger players. These sectors, however, can be operationally more specialized/tricky and require higher barriers to entry in terms of execution and expertise.
What Property Sectors Do You See as Bright Spots?
Upwards of 50% of the outstanding debt market has long-term, in-place fixed rate debt, keeping existing owners largely immune from the current realities of the debt market—all as they continue clipping solid NOIs across asset classes (outside of office). Strong fundamentals and a sizeable share of owners with fixed rate in-place debt further constrain activity and seller capitulation.
Large institutional investors are more active now and looking for opportunities to get into the market. With equities and bonds rallying since the start of the year, they’re also facing a reversal of the “denominator effect” that took hold over the last year or so, and they are selectively formulating deployment strategies. Does this mean they are opening the flood gates completely? No…but it means that they are approaching this year with a more much proactive desire to act on compelling deals.
