‘It’s Like A Mirage’: Investor Says Rate Cuts Won’t Be CRE’s Savior

While many in commercial real estate are waiting with bated breath for the Federal Reserve to lower interest rates and inject life into a struggling market, one investor thinks CRE is in for a rude awakening come Sept. 18 when the Fed is expected to make the first of several hotly anticipated rate cuts. 

That investor is waiting to clean up the damage.

“The broader problem is that people are waiting. It's like a mirage,” said Adam David Lynd, president and CEO of Texas-based The Lynd Group, which has invested $2.8B in multifamily real estate across four funds over the past two decades.

“They think there's water, and they're going to keep walking towards lower interest rates. And when they get there and they are lower, they're going to find out that that's not even the real culprit.”

The real culprit behind distress, specifically in the multifamily sector, is that rents are flattening or declining in many markets while operating expenses are skyrocketing, Lynd said. When expenses like insurance rates and taxes rise, they rarely reverse course and go back down, even in a lower-rate environment, he added. 

Based on this conviction, The Lynd Group, a national multifamily owner, operator and developer, is smelling blood in the asset class, teaming with New York investment firm Declaration Partners to buy up and turn around distressed assets. Declaration had $2.2B in assets under management as of March.

With billions of dollars in loans set to mature and some multifamily properties selling for cents on the dollar, Lynd said he thinks the next major distress cycle is right around the corner. 

“They can't continue to extend and pretend,” Lynd said. “You can't keep telling the lie ‘everything's OK’ when the last round of mortgages that you quote, unquote worked out are still unworked out. Great, you kicked the can down the road on this billion dollars of loans. But what about the next billion coming due?”

Office distress remains about three times the value of distressed apartment loans, MSCI figures show. But the pool of multifamily loans that risks falling into distress down the road amounts to nearly $81B compared to about $67B for offices, according to MSCI.

When heading into these types of distress cycles, Lynd said, two things are required to properly capitalize on opportunities — money and intelligence. Working with Declaration Partners checks both boxes, and The Lynd Group’s operating company will serve as the vehicle to go into the market, start hunting opportunities and deploy capital, he said. 

The assets that are coming to the partnership's attention right now have both broken capital stacks and business plans, Lynd said. This includes investors who couldn’t execute on value-add plans or had variable-rate mortgages that spiked in the higher-rate environment over the past few years and are now in trouble. 

To successfully create value in these distressed assets, there won’t be a one-size-fits-all strategy, Lynd said. Instead, every deal will be unique. 

“You're going to have to be an expert,” Lynd said,  “You're going to have to go in and look at every opportunity for what it is and [ask], ‘How can I create value from this property?’”

The overall capital stack on the deals The Lynd Group is doing is generally as follows: The general partner money, which usually makes up about 10% to 20% of the total equity, is about 10% to 20% from The Lynd Group and 80% to 90% from Declaration Partners. The balance of the equity comes from limited partners, and Lynd typically uses 60% leverage on debt.

The Lynd Group also has an advisory service that banks have enlisted to bring distressed assets back up to market value. The structure of those deals looks different depending on the asset and the lending bank, but Lynd and the bank could split the recouped value in half, or the company might receive a bonus if they can get the value above market value. 

This behavior from banks is a marked difference from how they functioned during the Great Financial Crisis. Back then, banks would sell assets to private equity at steep discounts, Lynd said. Now, they are hiring firms to help recoup some of the value and recovering more capital than they would if they dumped the assets today, he said. 

Another key difference between this cycle and the GFC is that there is a “truckload” of money on the sidelines, Lynd said. Because of that, he doesn’t anticipate values to decline as much as they did in 2008.

Still, it’s been a long time since the last major downturn in multifamily, and many of the younger people now in charge have never experienced that kind of cycle, he said.  

“Apartment has seen a 15-year run of nothing but upside and rent increases and values going up, and rates going down,” Lynd said. “That's a very lazy real estate market, right? And now you're going to have to hunt for your food, and you're going to have to fight for it.”

Many younger, inexperienced real estate players — and perhaps some older ones, too — have been counting on rate cuts to set things right. But that day is likely not coming anytime soon, he said.

“What we're seeing in the market is this really weird period where everyone's looking at each other telling everybody it's OK, and it's not OK,” Lynd said. “It is so far from OK that I believe that what is coming is going to really cripple some people because they have no idea how bad this is going to get.”