The most hazardous territory in the commercial real estate market—where the properties can’t meet their debts amid lagging rents, or are headed that way—is an aching problem for their owners. And a tantalizing opportunity for intrepid investors willing to venture into this blighted landscape.
Distressed investing isn’t a starkly visible presence in the commercial real estate (CRE) world. Not quite yet, anyway. But investing firms like Black Mountain Group are amassing sizable funds to buy these damaged assets and sometimes the debt that supports them, as well.
Pension plans and other institutions are slowly, quietly buying positions in these funds. By all accounts, this is a nice, if risky, opportunity for them. The affected properties’ prices have begun to slide, spelling bargains for the the bold, who hope to capitalize on turnarounds.
More and more properties are entering the distressed category, although this has been a slow-motion process. “There is often a lag when economic distress manifests in rent and occupancy declines,” wrote Victor Calanog, head of CRE economics for Moody’s Analytics Real Estate Information Services (REIS).
Helping the lag: Washington since last year has offered aid to wounded businesses, in the form of grants and low-interest loans. And residential real estate has been granted a freeze on foreclosures, called “forbearance.” While CRE isn’t covered per se, this spirit often extends to commercial buildings, according to real estate experts.
The result is a postponement of crackdowns on borrowers. A lot of lenders regard CRE loan delinquencies as a temporary phenomenon. “They think, ‘These guys were good to us before the pandemic, and now the vaccines are coming,’” observed Paul Norris, Conning’s head of structured products. If lenders foreclose now, “they’ll lose money.”
Amid the plummeting prices, a floor exists somewhere, because of all the distressed capital coming into the picture. Private real estate debt funds raised some $20 billion last year, the most of any strategy, by the count of data firm Preqin.
Nevertheless, some properties could take a long time to spring back. Those are the ones the distressed funds are eyeing the hardest. Retail, especially the much-endangered shopping mall, was on the downswing even before the pandemic.
Other real estate is imperiled owing to COVID-19. Offices are in extremis because of the uncertainty surrounding whether companies will need as much space in the future, now that people have a taste for working at home. And lodging has gotten hammered by the drop in travel, although an uptick has appeared lately thanks to growing inoculations. The question for hotels, especially in cities, is whether business travel will bounce back in the age of Zoom.
Large banks, still smarting from the shellacking they took in 2008 and under Federal Reserve capital constraints, aren’t eager to ride to the rescue of limping CRE. “We’ve seen a dislocation in capital markets as traditional lenders,” meaning money-center banks, “have stepped back,” said Joshua Pristaw, head of capital markets at GTIS Partners. That’s where the new cavalcade of distressed investing funds comes in.
But the annals of financial winners are festooned with those who bought ailing assets cheap and profited mightily as the investments improved, often with the aid of some tough workouts. Such CRE distressed funds have scored annual returns in the low teens in the past.