Increasing Activity Despite a Volatile Capital Markets Environment

Berkadia and Knight Frank teams in markets around the world are witnessing increasing activity as institutional investors find compelling opportunities in today’s volatile capital markets environment. Let’s explore some of the key observations and themes they are witnessing: 

Senior Debt 

Senior debt markets have become increasingly complex as interest rates have risen, shifting investor focus toward more nuanced risk and return analysis. The emergence of distress is now more subtle, more often seen in single-asset loans rather than widespread non-performing loan (NPL) portfolios, reflecting banks’ conservative approach. Lenders are also adopting more collaborative strategies, moving away from harsh penalties and working flexibly with sponsors on sales or refinances. This new approach underscores a significant shift from the ‘loan to own’ tactics of the past.

As interest rates peak and are expected to decline, the outlook for debt financing is improving. This trend is evident in the narrowing gap between 5Y SWAPs and prime net initial yields, suggesting that debt could become more attractive and unlock new capital market opportunities in the near future.

Structured Capital Solutions

Structured capital solutions, such as preferred equity investments, mezzanine loans and stretch senior loans are addressing financing and refinancing challenges and providing robust support to sponsors. Structured capital solutions offer elements of debt and equity capital in a single, versatile package that helps sponsors bridge the gap between their existing loan balances and the often-lower permanent loan proceeds they are receiving. These solutions also help reduce the common equity checks sponsors have to write. Since there are plenty of institutional investors providing these solutions, we have witnessed a wide range of cost of capital and a need to run wider process to ensure sponsors are receiving best execution. Overall cost of capital has increased 200-400+ bps since 2022. 

Joint Venture Equity

Institutional investors are much more selective when providing joint venture equity today. Many are focused on two key types of opportunities: “total return” and “yield”. The “total return” approach targets deals that provide 18%+ deal-level internal rate of return (IRR), typically with limited or no cashflow in the first few years of the hold period. While joint venture equity for development projects is difficult to attract today, certain development projects do fit well into this type of “total return” bucket. 

Conversely, the “yield”, or cash flow-focused strategy, is seeking deal flow that generates steady income from the outset. These deals aim for a first-year levered cash flow of 6.5%+ with a four to five year average levered cash flow of 8%+ with a 12%+ deal-level IRR. Certain types of structured capital deal flow and existing deals that generate strong cashflow are a good fit for this bucket of capital. 

Foreign Capital Remains Very Interested in U.S. CRE

While cross-border commercial real estate investments fell significantly in 2023, with a 45% decrease, foreign capital, specifically Japanese and Singaporean investors continue to seek opportunities in U.S. markets. Knight Frank’s Capital Gravity Model indicates a revival of U.S. outbound investments this year, with notable interest in sectors such as industrial/logistics and living sectors. This renewed interest reflects a strategic shift, as investors adapt to evolving market conditions and look for compelling opportunities in the U.S. CRE sector.

Clients are increasingly looking for strategic guidance to manage a mix of performing and underperforming assets, particularly in a fluctuating market, on a portfolio-wide basis (not just individual deals or properties). With strong relationships with buyers and debt & equity capital providers on a global scale, the alliance between Berkadia and Knight Frank allows us to offer the full spectrum of services, from refinancing, recapitalizing and sale to restructuring not just properties but entire portfolios, which has been particularly valuable in these challenging times. As with most in the industry, we are excited and optimistic about the rest of 2024 and beyond.

Berkadia and Knight Frank recently teamed up to film the webinar: Navigating Global CRE Equity and Debt Markets. Click here to watch.