Spring Finance Forum: Tremors to Be Felt ‘In Every Asset Class’
How bad is CRE financing going to get before it gets better? Commercial Observer's Spring Finance Forum convened the experts.
By Andrew Coen and Brian Pascus April 28, 2023 10:50 amreprints
Nearly a year to the day after commercial real estate financiers saw the first signs of troubled waters ahead, lenders and brokers yearned for market stability at Commercial Observer’s seventh annual Spring Finance CRE Forum in New York.
Last year’s annual CO event was held 363 days before on the same morning that government figures were announced showing the U.S. economy shrank 1.4 percent in the first quarter of 2022, setting the stage for a volatile climate that commercial real estate finance professionals continue to contend with today.
The 2023 Spring Finance Forum, which was held once again at the St. Regis Hotel in Manhattan, shined a light on gathering headwinds confronting a CRE industry already reeling from market dislocation spurred by the COVID-19 pandemic and the Federal Reserve’s nine straight interest rate hikes. The growing number of maturing commercial mortgage-backed securities (CMBS) loans is only worsening conditions.
The high number of CMBS loans scheduled to mature in the next two years in a higher interest rate climate has put the focus on restructurings, which will be far easier to land for traditional CRE developers, according to Rob Verrone, a principal at Iron Hound.
“If the sponsor has his or her own money to put into the deal, there’s a higher probability to get the restructuring done,” said Verrone during a fireside chat to kick off the forum moderated by Leo Leyva, co-chair of the litigation and real estate departments at law firm Cole Schotz. “The banks are basically telling the borrowers, ‘Pony up or hand the keys back.’ ”
Verrone noted that while he has raised third-party equity in the past to get restructurings done, the process can be lengthy, and oftentimes lenders are not willing to accommodate. He said the average restructuring can take six to nine months to get it done — “if you’re lucky.”
Distressed commercial properties have been brought to the forefront as CRE sponsors contend with increased borrowing costs coupled with challenges obtaining new capital with banks scaling back lending since last summer. Larger banks, which had additional lending barriers due to increased regulatory requirements, especially stepped back as interest rates spiked, with regional banks filling some of that void. Regional banks also are largely on the sidelines now, however, due to contagion from the March failures of Silicon Valley Bank and Signature Bank.
Tony Fineman, co-head of originations at Acore Capital, said he is hopeful that transaction activity will begin to resume at a healthy level soon as the reality of new higher interest rates sets in.
“It feels like we’re starting to turn the corner and the corner is not going back to where we were, the corner is stability,” Fineman said during the first panel, on stabilization, moderated by Dan Berman, partner in the real estate practice at Kramer Levin. “All sides of the transaction have to understand where we are in order for transactions to take place.”
Fineman added that there will be opportunities in the market as CRE values reset and banks are forced to sell loans at discounts when they reduce exposure in the sector. He stressed that the resetting environment will present opportunities in the junior part of the capital stack.
The panel also featured Lauren Hochfelder, co-CEO at head of Americas at Morgan Stanley (MS) Real Estate Investing; Neil Gupta, chief investment officer and executive vice president at Rudin Management Company; and Niraj Shah, partner at Rockwood Capital.
“From a general dislocation standpoint, risk is being repriced before our eyes,” Hochfelder said. “I think we’ll need some price stability or at least some conviction around where rates are and the economic outlook, etc., to bring people back to the table.”
Ralph Rosenberg, partner and global head of real estate at KKR (KKR), stressed during the second fireside chat that loans with maturities in the next two to three years are going to require some form of deleveraging, property sales, or handing back of the keys. He noted that private lenders will likely have challenges filling the lending void left by banks due to back-leveraging their books.
“I think new pools of capital will form to provide credit to this market, but I’m not convinced that the market generally — asset allocators and lenders — are going to have broad access to capital,” Rosenberg said. “The epicenter of this problem might be antiquated office, but the tremor is going to be felt by every asset class, everywhere in the world.”
Rosenberg said he expects the de-leveraging cycle to take at least three years and include much denial and “kicking the can down the road” via loan extensions. He stressed, though, that eventually CRE will see some recovery given the many positive attributes with many global investors wanting exposure because of positive cash flow, positive inflation hedges and challenges with building new products.
The forum was held a week before the Fed’s next scheduled meeting on May 2, where the central bank will consider whether to raise rates for a 10th straight session dating back to March 17, 2022. The string of rate hikes, which included four straight increases of 75 basis points, has brought the federal funds rate up to between 4.75 and 5 percent, a far cry from near zero borrowing conditions that existed in early 2022.
“They’re in a bind as every time they raise rates another bank will teeter because all of a sudden their book mark to market is worth that much less,” said Aaron Appel, senior managing director and co-head of New York capital markets at Walker & Dunlop during the second panel, which covered the Fed’s efforts to combat inflation.
Owners saddled with floating-rate debt and expiring interest rate caps have especially felt the pain of the Fed’s hawkish strategy, according to Josh Zegen, managing principal and co-founder of Madison Realty Capital. He noted that the soaring costs for protections against rising rates may prompt “forced selling.”
Owners saddled with floating-rate debt and expiring interest rate caps have especially felt the pain of the Fed’s hawkish strategy, according to Josh Zegen, managing principal and co-founder of Madison Realty Capital. He noted that a large amount of volume originated in 2021 under two-year caps and property owners will require “a huge amount of capital [to] right size.”
The second panel — moderated by Jennifer Recine, partner and co-chair of the real estate litigation practice at Kasowitz Benson Torres — also included Jason Kollander, partner and co-head of real estate credit at MSD Partners, and Anar Chudgar, co-president of Artemis Real Estate Partners.
It should come as no surprise that when the discussion turned to which asset classes are currently attracting investor attention, a fresh set of panelists — moderated by Kenneth D. Hackman, partner of global finance at Dechert LLP — took turns hammering the state of the office market.
Grant Frankel, managing director at Eastdil Secured, pointed out that office buildings need not only tenants to have value, but they also need to be filled by firms whose employees want to be back in the office. He added that the post-COVID landscape now has buildings competing against each other for tenants amid a corporate culture that allows people to work from home.
“There’s going to be a tremendous amount of repositioning in the central business districts,” Frankel predicted. “Yeah, some of these buildings are going to go down … from a lender perspective, be prepared [in your office exposure] that you’re probably going to own that for a while.”
Onay Payne, managing director of real estate at Lafayette Square, said that employers can no longer “hoodwink and bamboozle” employees into believing they need to be in the office three to five days a week to be productive. She noted that her firm is remote-first and that any future needs for office space will be used in a “more limited” capacity.
“I think we’re in a new age,” Payne said. “And we’re headed into a pretty rocky time for office investment.”
However, not everyone on stage took a doom-and-gloom approach. Chris Niederpruem, head of real estate finance at CIT Group, insisted that the “office is not dead” and that we are still in the very early days of a secular shift in office space utilization.
“Three years ago it was, ‘Nobody is ever coming back to an office again,’ ” said Niederpruem. “People are coming into offices, and anybody who has convinced themselves that you’re as efficient and as productive at home just wants to stay at home.”
One asset class that attracted a more positive outlook from the panelists was the multifamily and industrial sectors.
Multifamily sales are declining, however, according to Mark Silverstein, head of proprietary lending at NewPoint Real Estate Capital. Silverstein noted that there were more than $200 billion in multifamily sales in 2021, roughly $175 billion in sales in 2022, and only $17 billion in multifamily sales in the first quarter 2023, indicating a substantial slowdown in transaction volume.
“But we are active, and most groups out there doing multifamily lending are finding opportunities; borrowers are looking to borrow,” Silverstein said. “The areas that we’re seeing most activity are in construction loans that are maturing, and when someone wants a TCO (total cost of ownership) bridge loan where they want to be 20 percent occupied.”
During a one-on-one chat about the state of capital markets between Paul Vanderslice, head of CMBS at BMO (BMO) Capital Markets, and Bonnie Neuman, chair of the real estate group at Cadwalader, Wickersham and Taft LLP, the industry veteran pushed back on the perception that commercial real estate is in a dangerous place.
“The headlines are always worse than the actual news,” Vanderslice said. “We had a pretty rough 2022, mostly because of the Fed and Ukraine. 2023 was off to a good start, and then [Silicon Valley Bank] hit and people started focusing on real estate assets, and research reports and negative headlines came out one after another, continuing to this day.”
This switch in public perception has placed enhanced scrutiny on the risk of assets within CMBS markets, much of which is unfounded, according to Vanderslice.
Of the $400 million in CMBS loans that came out of special servicing in March, roughly 85 percent of them were resolved and returned to being performing loans, explained Vanderslice, who tried to set the record straight on the strength of these specific assets.
“What happened on those deals is debt was either forgiven or collateral was released or there was a paydown with an extension given, and [then it was] handed back to the master servicer,” he said. “So this notion that loans default, immediate REO, and they’re sold into the market at distressed prices, isn’t currently true.”
The final panel of the morning – moderated by Brian M. Cohen, director at Goulston & Storrs – featured several lenders from some of the industry’s largest debt funds discussing their tolerance to extend credit into an uncertain system.
For Drew Fung, managing director of debt investment at Clarion Partners (CPREX), the key word was confidence. A general lack of confidence in the direction of the market has kept lenders momentarily in check, according to Fung.
“If you have confidence in your valuations and confidence in your underwriting, what will help restore that, in large part, is confidence in the Fed’s direction in terms of raising rates, or if we get back to a more stable environment with a more dovish policy,” he said. “That’s going to help tremendously.”
Ronnie Levine, senior managing director at Meridian Capital Group, insisted the market is overleveraged right now and that a painful de-leveraging needs to take place to bring transaction volume back up. He noted that oftentimes on a refinance, borrowers are refinancing maturing loans from a 4 percent rate to a 6 percent rate, placing them in a painful position with few options.
“You’ve just got a mathematical problem: There’s too much leverage. Debt service coverage is straight math,” he said.
The abundance of leverage is tied to a lack of liquidity in the system, according to Jason Hernandez, head of real estate debt for the Americas at Nuveen Real Estate. Hernandez admitted that most lenders are following a levered lending strategy, and that even debt funds are not immune to the need for a healthy banking system — one anchored by the Wells Fargos and the Bank of Americas of the world — to continue without disruption, as private credit cannot do it alone.
“It’s really a capacity issue in the financing markets,” he said. “We are not creating capacity.”
Jonathan Roth, co-founder and managing director at 3650 REIT, took a realistic tone. Roth said no one should be surprised that the music has finally stopped playing; it’s the natural order of capital markets.
“When you have an environment when interest rates have been so low, people forget the true meaning of value,” Roth said. “And so there just needs to be a reset, and that reset occurs when people are forced to transact, not when they want to transact.”
“To echo that point, it’s more of a resetting of expectations for both the borrower and the lender,” added Laura Rapaport, founder and CEO of North Bridge. “There is something called negative leverage, and you might need to have debt that’s more expensive and in a different structure than you initially anticipated.”
Despite these comments that implored the audience to be more anchored in reality, the program ended on a relatively optimistic note with projections about the industry three years from now.
“To the extent that the world gets really bad, there’s going to be a whole new set of opportunistic buyers,” Roth said. “When somebody loses an asset through foreclosure, it’s an opportunity for someone else.”
The night before the forum, a welcome reception was held at the Mondrian Park Avenue Hotel. The event included a fireside chat moderated by CO finance editor Cathy Cunningham and featuring Samir Goel, co-founder and co-CEO of Esusu, a minority-owned fintech platform that helps residents build credit histories, and Chelsea Cutler, senior managing director of capital markets at CBRE (CBRE).
“By helping renters establish a financial identity and a sense of financial stability we can help usher them on that journey towards alternative wealth creation whether it’s homeownership or otherwise.,” Goel said. “What we’re trying to do is build a one stop shop for better financial health.”
Andrew Coen can be reached at email@example.com
Brian Pascus can be reached at firstname.lastname@example.org