Debt Is The New Darling For CRE Investors Looking For Alternative Deals

Under a cloud of economic gloom, investors across the U.S. CRE landscape are faced with a tough year for placing capital, and are looking for alternatives to the typical avenues as they search for returns.

As a result, commercial real estate investors are turning toward the relative certainty of real estate debt in its various forms as the top favored alternative investment class, according to a recent survey by CBRE. Though the economy is wobbly, debt associated with real estate – especially in-demand property types such as multifamily and industrial – can offer the certainty of higher returns.

“In a market of heightened uncertainty, debt becomes more attractive as an alternative investment,” CBRE U.S. President of Debt & Structured Finance Rachel Vinson told Bisnow. “That's due to the combination of need for short-term capital and a higher interest rate environment, which is providing opportunistic capital the ability to generate higher returns relative to other investment classes,” she said.

Real estate debt was the most attractive alternative investment, according to the survey, favored by nearly 16% of respondents. Next in line was build-to-rent and life sciences at just over 10% each, followed by self-storage, affordable housing and data centers.

The survey finding refers to the spectrum of possible CRE debt, CBRE Senior Director of Capital Markets Research Darin Mellott said.

“We were intentionally general on this particular question,” Mellott said. “In times like these, there will no doubt be investors looking for distress. However, there are others who will be happy to deploy capital for assets with stronger fundamentals as well.”

Distressed debt is increasingly easy to find as more property owners default on mortgage payments, and it’s growing in popularity in spite of the relative risk.

“There will be more opportunities to purchase distressed debt than ever,” said Thompson Coburn partner Simran Bindra, an attorney who primarily represents real estate lenders.

“Lenders will likely be more aggressive in terms of foreclosing on assets than they were during the 2008 crisis for a couple of reasons,” Bindra said. “The first is that this is a very different, and much less favorable, interest rate environment. This makes the potential exit for borrowers who are in trouble more limited than in prior years.”

Also, more financial institutions are hunting for deposits, he said. There is a push across banking institutions to build up deposits to try and fully match up to originations which, in turn, gives institutions an incentive to attempt to recoup capital and lend it out at the higher rates.

“If there are assets that do not seem to have a clear exit, lenders are more likely now than before to attempt to pull back their capital,” Bindra said.

A climate of more aggressive foreclosures may offer new opportunities for investors looking to distressed loans as a way to get the underlying assets on the cheap — so-called 'loan to own' lenders, who either make a premium on the transaction through higher rates, fees and exit premiums — or eventually foreclose and own the asset securing the loan.

“It's easy to imagine aggressive lenders with an appetite to purchase nonperforming debt and who would happily exercise remedies against the underlying borrowers to own the asset,” Bindra said.

“But it's also important to note that there are also active opportunities to buy performing debt,” Bindra said. “We've even seen an uptick in loan participations, for example. Financial institutions obviously want to keep making deals, but are balancing the needs to have originations match deposits and keep dry powder, and more willing than ever to bring on co-lenders and participants.”

Blackstone executives said on the company's fourth-quarter earnings call that real estate debt will be one of the prime focuses of its capital raising efforts in 2023, along with life sciences and sustainable energy.

The investment giant is considering a fifth debt fund, “which will be a meaningful chunk” of the $50B that the company still aims to raise to meet its goal of $150B, Blackstone President and Chief Operating Officer Jon Gray said.

In December, Bisnow reported Goldman Sachs is raising money for a new real estate debt fund, which will aim to fill the gap left by banks wary of lending during the current economic climate.

According to notices filed with the Securities and Exchange Commission, Goldman has begun raising money for West Street Real Estate Credit Partners IV, starting with an initial $366M.

Harbor Group International recently closed on a $1.6B fund, HGI Multifamily Credit Fund, to finance multifamily properties. One major institutional investor, the Canada Pension Plan Investment Board, has put $585M into the fund, according to Harbor Group. The fund offers capital at rates of about 8% to 12%.

“In the current rate environment, it's a good time to be a debt investor in the commercial real estate market, particularly in the multifamily sector, where fundamentals remain strong,” Harbor Group President Richard Litton said.

One reason is that multifamily owners are facing maturing debt and expiring interest rate caps, and so will likely face liquidity pressures and will need access to debt capital, Litton said.

Maturing CRE debt is ballooning, according to a recent report by CRED iQ, which found that $162B in debt associated with all property types is coming due this year, with much more to follow in the coming years.

“As many traditional lenders remain on the sidelines, there’s an active market for alternative lenders in the multifamily sector,” Litton said. “We remain committed to our investment strategies, focusing first and foremost on fundamentals at the property level.”