Canyon Partners’ Nicholas Baccile Holds Court on Debt & Equity Markets

This conversation has been edited for length and clarity.  

Commercial Observer: What is your specialty at Canyon Partners?

Nicholas Baccile: Our business has the ability to invest across the capital stack. We invest primarily out of closed-end vehicles, and that allows us to originate everything from senior loans, mezzanine loans, preferred equity investments, limited partner equity, and we have, in our 35-year history, invested general partner equity. We can invest 100 percent of the equity in transactions, so we really cast a broad net across the different platforms we have and our ability to capitalize different types of transactions. 

Our primary focus over the past five years has really been transitional and ground-up deals across all asset classes. Certainly our opinions of asset classes change over time, depending on where we are in the market cycle, and we’re also at the forefront of launching a core-plus strategy. 

Which asset class are you most focused on today? 

I’d say multifamily is an asset class we view favorably. We’ve continued to see demand throughout the U.S. for multifamily rentals because of the high cost of homeownership, because the younger demographic wants to be more flexible in terms of where they can move — it’s not like the Baby Boomer generation who bought a house and stayed for 20 years. We’re seeing growth in markets like Florida and Texas, more broadly. We continue to view those demand trends more favorably — the last 12 months we saw significant amount of supply came into the marketplace for multifamily, and what you’re seeing today is supply is being absorbed, and because of the higher interest rate environment we’ve been in for last 12 to 24 months its been hard to get new ground-up multifamily deals capitalized. In the future, we see multifamily supply will taper off significantly, so we think supply-demand fundamentals will be an attractive environment to invest in, across both debt and equity. 

And on the other end of the spectrum? 

I don’t want to rail against it too much, but on the other end of the spectrum you have office, and the supply-demand fundamentals are not as interesting to us. It’s a market that’s broadly oversupplied, demand has pulled back pretty significantly. Whether it’s because of the new work mandates from COVID, being in the office only three days a week, or the advances in technology to do Zoom interviews like this, the demand dynamics around office have changed significantly, and it will take time for the supply-demand fundamentals to revert to equilibrium before we see growth and vacancy rates decline. 

What were your thoughts on the Federal Reserve’s interest rate cut in September? 

What they can’t allow to happen is that they reduce rates and inflation starts to trend back upwards, then you go from 5 percent interest rate to potentially a higher interest rate environment to bring the inflation further down. I think what that [rate cut] does in near time is it starts to kick off potentially some refinancing activity, and my hope is it kicks off new acquisition activity. Private real estate market tends to react more slowly to changes in these types of fundamentals. You see it in the public markets with REITs trading at an NAV [net asset value] premium, compared to 12 to 18 months ago when they were trading flat or at a slight discount to their NAV, so you’re seeing the market already react to interest rate cuts, and the private markets take more time. Call it 12 months, or so, the market will probably experience more cuts, and I think that thaws the investment sales market and the capital market to create more transaction activity, which has been fairly muted this year. 

What was your assessment of the debt and equity markets for the first nine months of 2024?

The equity capital providers have been very focused on providing capital into primarily existing assets, within what people call gap financing, or preferred equity, if you will, where they have ability to earn equity-like returns but take debt-like risk. That’s been an attractive area of capital stack to play in this marketplace, particularly as you see valuation resets. So equity investors aren’t going into these deals from appraisals that are two years old. They are going in based on today’s cap rates, and are hopefully able to take a last-dollar risk they are comfortable with and at the same time earn an equity-like return for that risk. 

But it’s not all sunny, right? 

Right. In contrast to that, you’re not seeing ground-up developments get capitalized. What I hear from developers in the markets I cover is that the equity players are sidelined for new ground-up development, and that’s something that may change over the next 12 months, as interest rate cuts occur. That brings down cuts on assets that improves the yields on assets you can achieve, and so that’s the most interesting area you can play, the preferred equity space. It’s where the existing owner doesn’t want to do a cash-in refi. They’ll bring in a new preferred equity provider to fill that gap, and it allows an existing owner to put new debt on an asset through positive growth into the future.  

Special situation funds — mainly in multifamily — are popping up. What’s your assessment of that landscape? Are these private equity funds creating a new world of finance? 

I think it’s really two separate things, at least in the way we think about it. On one hand, institutions are replacing banks as capital providers; that’s really occurring on the debt side of the capital stack. You see retrenchment in banking, and what that is is a reorientation of risk. While the banks have lowered their last-dollar risk, their LTV [loan to value], their LTC [loan to cost], they’re still lending. They have to deploy capital over time to grow the books, to keep the balance sheet healthy, to earn income for shareholders. But what they’ve done is lowered LTV and shifted last-dollar risk, particularly to senior loans, from their own balance sheet to private capital providers. That’s where you hear about bank retrenchments and where [debt funds] are filling the gap. They’re not filling an equity gap, they’re filling a debt gap. 

And what about special situation funds?

They are separate and apart from the debt conversation. Really, I view them as competitors in the equity space. These are groups that are really nimble, really flexible, really sophisticated in how they can provide capital solutions to the marketplace. They probably won’t compete further down in the debt end of the capital stack and not take full equity-like risk, but they’ll be situated somewhere in the middle. It’s where you’ve seen a lot of the equity guys go to play because you can create structures that are advantageous for your capital — you can say I want to go from 65 percent LTV to 85 percent LTV, depending on where your risk appetite is. They all operate very differently and everyone has their own risk appetite.  

Which asset classes do you feel are underrated for investment opportunities? Which ones are oversaturated?

I perhaps would say in the living sector. There are still very attractive supply-demand fundamentals for student housing. It’s a shift that started to occur when COVID happened, where, and this is strictly my personal view, almost a guess, but I think the universities saw the amount of liability they were facing when COVID started with everyone getting sick and it created an opportunity, knowingly or subconsciously, for them to shift liability from their own balance sheets to private developers. So what you’ve seen happen is a proliferation over the last four years of “on campus” student housing being developed, where students have gone from living in really old, low-quality dorms to living in brand-new housing. When I was in school, we lived in a six- or seven-bedroom house that has since been condemned. The dynamic and the trends that have spun out since COVID of high-quality student housing being developed and the insatiable demand from students for that product type is something that I think will continue at Tier 1 universities. You’ll continue to see growth at enrollment at those schools that will continue to create demand in that supply. And there’s only so much land you can develop at the universities. So I think those supply and demand fundamentals will be attractive going forward. 

And what about oversaturated? 

I don’t know if it’s being overcapitalized, and I think we view the asset class favorably, but I think it’s going to be very interesting to see, long term, how data center space plays out. It’s very capital intensive, there’s an incredible amount of demand, and that’s why you’re seeing so much capital flow into the space. It’s causing a significant amount of development to occur, and it will be interesting to see, as technology becomes more efficient, how that asset class fares over the next 10 to 20 years. 

What was the most complex investment deal you’ve worked on in your career and why?

I think the most complex transactions are the ones that require the most nuance around the capital stack, because it creates a lot of different layers of complexity. Back during COVID there was uptick in volatility into the marketplace and the capital markets shut down for a bit, and so what that caused was an inability for lenders to shift some of the loans they originated from their warehouse lines into CRE [collateralized loan obligations], single-asset single-borrower CMBS, and conduit CMBS into the public financing markets. And so, when that happened, there was an opportunity for us to effectively acquire a portfolio of loans from another counterparty, and those were all performing loans in the hundreds of millions of dollars, in terms of portfolio size. And in order for us to achieve the return that we have for our investors and our clients we had to bring in a leverage provider to effectively finance that acquisition, and that to me is as complex as it gets. Buying and selling assets, we do that day in and day out, and we’ve been buying loans for a long time as well, but that portfolio was unique in that it was a larger portfolio in terms of size, and we got to form great relationships with banking counterparties. But creating the structure that allowed us to purchase those loans wasn’t easy. We started in May and closed in October. 

Brian Pascus can be reached at bpascus@commercialobserver.com