Commercial Real Estate Financing Experts Look Beyond Borrowing Costs
A day after the Federal Reserve paused interest rates for a second straight meeting, commercial real estate lenders and brokers that Commercial Observer assembled for its eighth annual Fall Finance Forum voiced hope for some clarity from the central bank that would in turn spark a revival in transaction volume.
“Certainty is the most important thing in the market,” Michael Wiebolt, Blackstone (BX)’s global head of securities in its structured finance group, said during the forum’s opening keynote Nov. 2 at the the St. Regis Hotel in New York.
Wiebolt said in a discussion moderated by CO Executive Editor Cathy Cunningham that the Fed is giving some mixed signals that it may be near the end of its interest rate hike policy while also remaining committed to fighting inflation. He noted that even if the Fed stops raising rates, the CRE industry may be facing higher rates for a longer period based on recent signals from the central bank.
Since launching Blackstone’s structured finance group in November 2021, Wiebolt has been focused on investing in sectors with positive tailwinds in terms of growth potential. For 2024, Wiebolt continues to see strong fundamentals for data centers given increased demand, and also student housing as more students across the globe seek higher education opportunities in the U.S. He said Blackstone has no current plans to invest in challenged sectors like office where the basis has been reset.
Warren de Haan, CEO of Acore Capital, said the Fed’s decision to hold interest rates steady on Nov. 1 was “potentially a good start” to helping create stability and pour more liquidity into the securitized CRE markets. He cautioned that rising 10-year Treasury yields and wider credit spreads remain barriers to jump-starting more transactions, but he sees lending opportunities over the next two years for non-bank lenders like Acore.
“On the tailwind side, I personally have never been more excited for the opportunity in commercial real estate credit in 2024 and 2025 because of these cyclical and secular changes, with the banks retrenching,” de Haan said during the second panel titled “Setting the Scene: 2024 Finance Outlook.”
The first panel — moderated by Tzvi Rokeach, a partner at law firm Kramer Levin — featured Philip Adkins, managing director and head of real estate debt origination at Barings; Abbe Franchot Borok, managing director and head of U.S. debt at BGO; and Jessica Bailey, president and CEO of Nuveen Green Capital.
Adkins said higher interest rates for longer will result in continued strain on the capital markets and potentially also lead to some widening cap rates. He expects transactional volume to increase next year, but also expects distress to worsen over the course of 2024 and 2025.
A key component toward “level-setting” the CRE capital markets, according to Adkins, will be flushing out roughly $1 trillion in outstanding office loans in the collateralized loan obligation market. That flush could end up a “slow trickle,” he said, as institutions seek extensions and write-downs over the next few years.
Franchot Borok said transactional activity will likely remain roughly the same through the first half of 2024. She noted that loan-to-cost (LTC) is a metric taking on greater significance when tackling refinance deals
“We’re focused on very institutional, well-capitalized borrowers and making sure we get the right alignment with those groups,” Franchot Borok said. “We are very focused on LTC today to ensure that borrowers on the refinance side, where we really have to pinpoint a value today, that we have the proper alignment and borrowers are recommitting to the asset where they need to.”
The dislocation in the CRE capital markets has prompted some lenders to look to Commercial Property Assessed Clean Energy (C-PACE) loans as possible solutions to refill interest reserves or to buy time for property stabilization, according to Bailey, a leading C-PACE lender. She said the current environment has resulted in increased partnerships with C-PACE lenders as a way for senior lenders to avoid having to take back the keys on distressed assets.
While the CRE market has faced a shock to the system since the Fed began aggressively hiking interest rates in early 2022, conditions are not the same as during the onset of the COVID-19 pandemic. Liquidity then was truly frozen, according to Jason Kollander, a partner and co-head of real estate credit at BDT & MSD Partners.
“Now we’re testing where values are, and we’re testing where borrowers and sponsors have the strength to support assets for a year, two years, three years to the other side of this,” Kollander said during the second panel titled “Surmounting the Maturity Wall: Approaching the Summit.”
“I don’t want to go so far as to say lenders are in it together with the sponsor, but in some ways we are as we all want to see this other side and maximize value for everybody’s positions.” Kollander continued.
The second panel — moderated by Paul “Tad” O’Connor, a partner and co-chair of Kasowitz Benson Torres’ real estate litigation practice — featured Sarah Miller, director of the real estate finance group at First Citizens Bank (FCNCA); Matt Pestronk, president and co-founder of Post Brothers; and Mark Silverstein, senior managing director and head of proprietary lending at NewPoint Real Estate Capital.
Borrowers are struggling to make deals pencil amid the current market volatility, which has resulted in more cash-in-refinancings and preferred equity in the capital structure, according to Silverstein. He noted that preferred equity is especially coming into play with agency deals in the multifamily sector.
Pestronk recalled that, during the Global Financial Crisis of 2008, positive or neutral leverage on new multifamily properties was what jump-started transaction volume, and he could see a similar dynamic playing out in this cycle.
“Once that happened, credit spreads started to normalize, and I think that will all happen in about 14 months,” Pestronk said. “There was distress in the market until 2013 or 2014 in the last cycle, but the rest of the markets were sort of normalizing in 2010.”
The next panel, “Open for Business? Top Financing Sources Talk Availability” moderated by attorney Y. David Scharf of Morrison Cohen, examined sources of financing amid a higher interest rate environment.
Grant Frankel, managing director at Eastdil Secured, began by dispelling the notion that CRE is facing a liquidity crisis, calling it a “misnomer.” Frankel argued that existing debt wasn’t underwritten to withstand the cost of capital that comes from the Secured Overnight Financing Rate (SOFR) — an interest rate that determines interbank lending and the cost of borrowing — sitting at 5.3 percent. Much of the liquidity pullback, then, is simply about working through where existing debt currently sits in relation to SOFR’s changing position, Frankel said.
“Various capital sources are available, but it’s really about resetting expectations on what the coupons are,” he said. “On the other side of 5 [percent], everything sounds expensive relative to what we had over the last 10 years.”
Patrick Mattson, KKR (KKR)’s president and chief operating officer, described the lending space as a tale of two realities. The private credit space is operating on the back of deep wells of drawdown capital, while the commercial banking side has seen an honest-to-God material slowdown since the regional banking crisis this past spring.
“If you’re a private debt fund … it’s a great time to lend, and we’re seeing activity there, not only in our private fund but in others active in the space,” said Mattson. “On the bank side … there’s not a lot of competition, and the pullback from banks has been pretty noticeable in that market.”
However, Carina Kalaw, managing director at Bank United, a regional bank headquartered in Miami, argued that the banking sector needs to be viewed as composed of competing segments rather than as a monolithic industry, and argued that four factors go into whether commercial banks will make loans in this higher interest rate climate.
The first is whether a sponsor has an existing relationship with the lending institution; the second is whether a project’s cash flow can service the loan; the third is the size of the loan itself; and the fourth and perhapst most important factor is whether the sponsor has existing deposits at the bank.
“The real, more important piece is that a lot of regional banks are motivated by ancillary business,” explained Kalaw. “If the sponsor has what we call ‘the Big-D’ — it’s not default, it’s deposits — that will go a long way to get the financing done.”
The ensuing fireside chat moved away from lending and into the intricacies of commercial mortgage-backed securities (CMBS). CO’s Cunningham sat down with Michael Cohen, managing partner at Brighton Capital Advisors, for a conversation examining what many consider to be the most mysterious region of commercial real estate finance.
“What we do is make a cumbersome and complicated and unknowable process understandable to the borrower and their attorneys,” said Cohen, when introducing his business to the audience. “It’s an institutionalized process and it’s a banking process, and banking is done by consensus building.”
Cohen discussed the importance of understanding the objectives of the special servicer, who manages a defaulted CMBS loan, and the controlling class bondholder, who holds the lowest portion of the CMBS bond and ultimately carries the keys to any mutual solution. But more than anything, he stressed the need for sponsors and borrowers to be proactive and avoid waiting until the 11th hour to bring their troubled loan to the special servicer’s attention.
“Don’t wait. If you go in at the 11th hour, then the lender has full control,” explained Cohen. “Unless you’re planning to give the keys back or litigate, if you even have some reasons to litigate, then you have no other power. Those are your two power points: ‘No’ or ‘I’m going to sue you.’ Other than that, you’re at their mercy.
“These servicers have surveillance teams, that’s all they do. They know your loan, they’ve been to your property, they’ve seen everything,” Cohen continued. “You’ve got to get there early. The reason is, also, if you get there early you can make modification proposals to them and you have time to let it socialize through the system.”
And while the CMBS business thrives on periods of dislocation — like the one we’re currently in — Cohen tried to warn the audience that we’re still in the early innings of a long process of devaluation that will ultimately impact every CRE asset class, not just the beleaguered office sector, or suddenly vulnerable multifamily properties, many of which used floating-rate financing.
“We are going to have a devaluation across all asset classes,” he said. “We don’t know where the bottom is. We’re just getting done with the pregame stretch. We’re nowhere near the beginning.”
Finally, the mid-morning symposium entitled “Analyzing Asset Class Performance & Capitalizing on Key Distressed Opportunities” ended with a set of CRE executives analyzing asset class performance and sharing where they believe investors can capitalize on specific distressed opportunities.
Matt Rosenfeld, head of U.S. debt at Cain International, said that for the last four years his firm couldn’t get close to the multifamily space — which was viewed as a relatively safe, core asset class — but a shift has occurred in the last six months as the supply side has ramped up to the point that the U.S. has been delivering up to 700 multifamily units per day. This supply spigot has changed the equation for investment firms like Cain International, whose cost of capital is very high.
“The macro forces have tapered demand over the last few months, few years, as this master plan balance has emerged,” said Rosenfeld. “We’re looking at multifamily as a very selective [investment], we’re starting to see pricing has widened, there’s an opportunity to invest in the space, but there are markets where we don’t particularly want to go.”
Dan Buehrens, senior vice president at Brookfield Asset Management, said his investment firm has found compelling opportunities to provide cash-neutral refinancing capital for what were once bank-only construction loans for multifamily new development.
He said that the targeted debt yields just don’t work for commercial bank underwriting standards today, and that has given private credit players the chance to enter into a more restricted bridge lending space.
“To the extent that the supply story makes sense, the basis makes sense, there’s now an opportunity to price something to our cost of funds that we really see as a discount to replacement cost with a ton of sponsor equity still behind us,” explained Buehrens.
When examining the strength of sponsorship, Yorick Starr, managing director at Invesco, said that while his firm has taken comfort in lending to institutional investors, there are times when those have been the sponsors who have had to hand back the keys.
“You’re sort of saying, ‘Hang on, I gave you the money because you have all this money and it’s not penciling out?’ ” recalled Starr. “But it does come down to understanding the underlying real estate, the market dynamics, and, if you’re in a value-add business plan, then does the person providing capital know what they’re doing — because something always goes sideways.”
Starr said taking “a property-first mantra,” rather than merely relying on sponsor reputation, has helped his firm navigate the recent distress in the marketplace.
“It sort of helps us come up with a thesis: Is there potential stress on the asset? How much do you need to rely on the sponsor? But clearly sponsorship is paramount as well,” he said.
Andrew Coen can be reached at firstname.lastname@example.org. Brian Pascus can be reached at email@example.com.