KKR’s Matt Salem Talks New Strategies and Fresh Products in Tough CRE Market

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Numbers talk, and the growth of KKR’s platform has been impressive. Since 2017, its real estate credit division has grown from $2.5 billion in assets under management to $33.9 billion today; its total originations have skyrocketed from $2.4 billion to more than $35 billion today; its real estate investment trust — KKR Real Estate Finance Trust — has grown from $2.5 billion to $7.9 billion; and it’s now invested in $9.4 billion of securities, compared with $400 million back then. 

Further, it had two pools of capital in 2017, but now has seven, including bank and insurance capital. 

Commercial Observer sat down with Salem, a Kansas City native, at 30 Hudson Yards in mid-September. 

This interview has been edited for length and clarity.

Commercial Observer: The past year has been a tough period for many in our industry. How has it been for your team, and what are some of the key opportunities you’ve been finding to transact? 

Matt Salem: It’s certainly been a very interesting time. In navigating the volatility, and the opportunities and the challenges it creates, our team has never been busier. Luckily for us, we have a pretty broad range of capital and so we’re trying to take advantage of market conditions because we do think it’s a lender’s market. Banks have pulled back, and we’re trying to step into that void, lend at higher rates and lower loan-to-values, and grab market share. At the same time, we’re doing a lot of asset management and surveillance,  making sure we’re taking care of our existing portfolio.  

When I think about how busy we are, it really comes down to the fact that everything we’re doing is heightened right now. We’re lending because we want to take advantage of the void that exists; we’re buying securities because we want to take advantage of the volatility; asset management is a high priority right now, especially as it relates to office loans; but we’re also focused on building and growing our business. We’re trying to educate the broader market on what’s going on in real estate credit, and fundraise and bring in more capital so that we can continue to make the most of this moment in time. 

Are you therefore looking at this moment as a period of growth for KKR, in terms of acting on opportunities that didn’t exist a year or two ago? 

I think that’s right. Banks represent roughly 40 percent of the overall lending market. We think they’re pulling back, and it’s pretty clear someone has to step into that void. The two places that we think will be outlets for that capital will be alternative lenders, like ourselves, and capital markets, like commercial mortgage-backed securities (CMBS). Those are both areas we’re very actively involved in. 

When I think back over the history of alternative lending within real estate credit, it was a very small business pre-Global Financial Crisis [GFC], and then post-GFC you had the first big pullback from the banks and deleveraging of the economic system. That’s when a lot of these businesses got started and stepped into that void. 

We hope this period will create an opportunity to grow our business going forward. A lot of it will come back to track record, and how we do from a performance perspective. But, given the focus we have on larger loans and institutional sponsors, especially in the property types we’ve primarily focused on — multifamily and industrial — we think the segmentation will help drive performance as well.

Lender-borrower relationships must also be pretty paramount right now. 

Yes. I think in good times, and certainly in more difficult times, there’s a great opportunity to build a relationship with our sponsors. We’ve got great borrowers, and we asset-manage all of our loans ourselves, so there’s that direct connectivity there from things as simple as draw requests to modifications that are happening in the portfolio. 

Our stability of capital has also helped deepen these relationships. We’ve gone through not only COVID, where we also continued to lend, but now this inflationary interest rate environment that’s very abnormal. A lot of lenders only have one product to offer so they’re out of business, whereas we’ve added products since this volatility started and are actively lending in the market. That stability is key because we’re going to be there; we have capital and people trust us.

What are some of the new products that you’ve added over this past year? 

The big product that we’ve added is a bank product. We formed a separately managed account with an Asian bank and we’ve never really had that core type of capital previously. We’ve had insurance capital, but this is 50 percent loan-to-value, bank-style capital, and floating-rate for the most part. It’s been great to have that product, and we’ve actually lent around $400 million in that strategy this year, and it just turned on in August.  

So, if you think about the suite of products we offer our clients, we can sit down and offer a bank type of loan, we can offer
insurance-type loans — which could be floating or fixed — and then we’ve obviously got the more bridge, debt fund-style of capital where we can do value-add or construction financings. We’ve pretty much the full suite of products across the board now, and all of those have decent scale to them.

Of all those buckets, where are you most active today? 

We’ve been most active on the insurance capital side, where we’ve seen a lot of our borrowers gravitate to fixed-rate loans over the course of the year. A lot of those borrowers were historically floating-rate borrowers, but, given the interest rate environment and where short-term rates are on SOFR, we’ve seen preference shift from floating to fixed. 

We started to feel the banks pulling back starting in the middle of 2022 as interest rates started to rise. How palpable was the retrenchment for you at that point, and then following the regional banking crisis?

You’re right to identify there have been two phases to this. In the middle of last year, the Federal Reserve-regulated banks — the big money center banks that we all know — pulled back from the market dramatically, but, at the same time, the regional banks continued to lend normally up until March. Since then, we’ve definitely seen them pull back from the market. They’re not out, and it’s not as stark as you saw with the largest banks last summer — each bank is in a different liquidity position and capital position— but their participation is clearly down. 

At the same time, you’re now starting to see loan portfolios come out of the banks. We have a special servicer, and part of our business is buying conduit CMBS B pieces. That’s in a securitized format, but we are gearing up to look at some of these balance sheet loans being sold by the banks. The FDIC just launched the Signature portfolio, which is a $60 billion portfolio, so a bit abnormal in size, but we’re gearing up for that side of it. So not only are the banks pulling back from lending, but there’s a good opportunity for us to invest some capital, too. 

In terms of lending preferences today, what are you lending on, and what won’t you touch?

I would say the major food groups we’re focused on today are industrial first, then multifamily, student housing and self-storage as the big ones. We’re looking at data centers, as well — we haven’t done anything there yet, but we’re actively looking at that sector. 

Are you considering any office opportunities? 

We are looking at them, because we think there’ll be an opportunity to lend on really high-quality office that’s stabilized. We don’t want to take a lot of leasing risk until we understand where the market is going, but we’re certainly looking at everything that’s coming in and evaluating the sector because we know there’s a huge pullback in liquidity there. Over time, I think we’ll be a liquidity provider in that market, but we’re waiting to see how it plays out a little bit first.

A lot of lenders are saying the 2024 and ’25 vintage could be the best of their careers in terms of loan quality and sponsorship. Do you agree with that? 

I think the best lending is ahead of us. I hope this period of volatility doesn’t go all the way to 2025 [laughs] — next year would be just fine. We’re all transacting at lower volumes, but we’re finding ways to invest and stay on pace. I think the full weight of the lack of capital will be felt when you start to see transaction volumes pick up, because lending capital is not going to pick up as quickly. So that’s one place we think we’ll be able to step in.

How are you figuring out cap rates today? 

One is through being integrated with a real estate equity investing business. We’re seeing firsthand where transactions are closing, so where cap rates are, and we’re adjusting everything accordingly. I will say the biggest consideration in terms of whether or not we’re making a loan is where we think the value is. So we’ve adjusted cap rates materially to account for the current interest rate environment.

Are you looking at loan purchases primarily as an opportunistic or discounted play today, or paying at par to add to your portfolio?

They can be both, but I do think we’re viewing them as more opportunistic in nature. We’re also thinking about it more on a portfolio or pool basis — so, buying the entire pool as opposed to loans on a one-off basis. The reason I think it’ll be more opportunistic-
oriented, is if we’re going to buy something, say, for the insurance company [bucket of capital], there’ll be stuff that clearly can fit in there, but we tend to have a bias to make that loan ourselves because we like our own cooking. Whereas, on a more opportunistic basis, if we can buy a loan at a little bit of a discount we can try to make more of an opportunistic return.  

As you mentioned, KKR is a big buyer of CMBS B pieces. How’s that activity unfolded in the past year? 

It’s been interesting to watch. Our vehicle has the ability to transact both in the new issue, primary market and in the secondary market. Over the course of the last nine months, as the volatility came into the market, we shifted from the new issue market — which didn’t reprice as quickly — to the secondary market. 

If you look at the activity in our capital over the course of the last nine months, it’d be heavily weighted towards SASB [single-asset, single-borrower] deals, buying in the secondary market. We’re seeing slight discounts come from money managers selling and we’re able to acquire really high-quality pools that are backed by industrial, multifamily and other favorite asset classes.

Fast forward to today, the primary market has widened out a lot and we’re actually transacting right now on our first B piece where the underlying loans are five-year loans. That market has repriced by 400 or 500 basis points, and so now we’re beginning to invest there. We’re the largest buyer of risk retention in that market, so we’ll continue to be active there. 

It’s a tough issuance market right now, with interest rates so volatile. However, I think the banks have done a good job of creating a new five-year product, which will attract borrowers. I also think as we get some rate stability, we’re pretty bullish on issuance going forward for CMBS, because we think as the banks pull back, again, one of those outlets will be the capital markets. I don’t think it’s this quarter or next quarter, but as we think about the back half of ’24, I think you’ll see issuance volumes pick up.

Your special servicer, K-Star Asset Management, went from zero to 40 people over the past year and a half. 

Yes. We’ve hired about 40 people at K-Star and have around $46 billion of special servicing rights — mostly in conduit CMBS but we have some SASB CMBS. It’s an active business, and pretty well staffed at this point.

What are you seeing today in terms of workouts in your own portfolio?

It’s been really muted, with very low delinquency rates across our portfolio. I think the reason for that is, we’re starting with lower leverage on stabilized assets, so there’s a lot of cash flow. These are — on the conduit side — fixed-rate loans with very, very low coupons, so there’s super high coverage to start with. We’re beginning to see a little bit of office delinquencies here and there, especially when the borrower needs to sign leases, or bring capital into the equation. But there’s still very, very, very little delinquency overall. 

How much of a competitive advantage has your asset management business given you during the volatility? 

We’re only starting to see the competitive benefits now. We have a very experienced team there, and, in my mind, there are a couple of places where we’re going to see the differentiation. One is scale — having that sophisticated engine that can not only asset-manage and special service but also underwrite bigger portfolios. That’ll be a big differentiator for us — especially as you think about the market offering more pools of loans. What used to just be SASB or conduit CMBS now extends to banks and the FDIC selling loans. There are only a handful of us that really have the capability of underwriting some of these large pools. 

Two, borrower experience and deeper client relationships. I think that will come over time, and, while we’re doing it on a day-to-day basis, you really start to feel the benefits of that later. For us, everything comes back to our investors and optimizing our returns. Having our own team there that is part of us and has the same credit DNA — with us all thinking about risk in the same way — that’s really where the power is going to be on the outcomes side and getting the best returns for our investors.

KKR has also been actively lending in Europe, I understand. 

We built out a team based in London, and we’ll continue to expand that business. Like in the U.S., our London team is fully integrated with the equity investing team, so they get those synergies of market information, and that connectivity. We’ve actually been quite active over there and done things for insurance capital, as well as some of our debt fund capital. The business is ramping up pretty well, with $500 million this year so far. We’ve done a couple of U.K. deals, some industrial deals and student housing deals in Spain, a multifamily deal in Dublin … it’s pretty diverse.

Nothing in Edinburgh yet? 

Not yet [laughs].

Still time. Bringing it back to the U.S., what are you expecting in the fourth quarter in terms of distress and dislocation? 

I think you’ll see some selling coming into the fourth quarter and going into next year, especially by the regulated institutions who want to clean up their balance sheet and relieve capital. I think you’re going to predominantly see banks selling, but some insurers will also probably sell a little bit, too. 

I don’t think it’s a huge thing from a borrower-base perspective. What they’re going to be reacting to is just overall pressure as time goes on: carrying costs, and loans come due, or having to rebuy interest rate caps. That will play out over the next year and a half to two years. As time goes on, more of that activity occurs. There’s more maturities and more interest rate caps needing to be bought. That’s where you’ll start to see the real pressure in the market.  

You’ve transacted through several cycles. How does this period compare with the GFC? 

I always find these markets to be really interesting, and each one is very different. This one feels a lot more manageable than the GFC did, which felt much more like the sky is falling. At the same time, there’s obviously really acute issues and valuation issues within commercial real estate. For office, it’s as bad as the GFC, maybe worse — the liquidity there is just really, really poor. 

For me, it’s been intellectually rewarding from a management perspective. We’ve got a lot of young people on the team that didn’t work through the GFC or other volatile moments. So, just making sure we keep the team motivated and that they understand what we’re trying to accomplish and stay focused on what we can control is important. It’s a big educational opportunity for them. 

We’ve also just been very busy trying to grow the business and get in front of our investor clients globally, explaining to them what’s going on and where the opportunity is — because we don’t want to miss this window to invest, and we also don’t want to miss this window to develop a relationship with the client.

What are you hearing from investors broadly, in terms of how they’re looking at U.S. commercial real estate? 

There’s a sequencing that’s happening in investors’ minds. Right now, I’d say they’re very focused on credit. They recognize this theme of the banks pulling back — they’ve seen it before. Coming out of the GFC, they saw the opportunities it created. So, there’s global consensus that there’s relative value in real estate credit today and we’re seeing a lot of allocations there, even though there’s a denominator effect happening and people are being more conservative. 

I also think that there’s a sequencing aspect to allocations, too, and I can see a timeline where it’s real estate credit now, real estate equity later, and the best opportunities will be in the back half of ’24 going into ’25. The market is smart and investors see some stress in the system and, I think, therefore they’re forming their ideas about how they want to allocate capital. And that’s a big difference between now and the GFC. There is capital being committed — you can raise capital today and you can invest capital today, whereas the market was much more frozen in the last go around.

Lastly, a lending peer asked me to ask what you — as a Kansas City native — think of Patrick Mahomes’ restructured $450 million contract? 

[Laughs] I think he’s worth every penny. 

Cathy Cunningham can be reached at ccunningham@commercialobserver.com.