‘Compassionate Capitalism’ Has An Expiration Date, And Investors Are Eyeing Their Targets

As the coronavirus pandemic wears on, real estate players are starting to formulate theories about how upheaval will play out in the real estate market, and where and when the opportunities will emerge as a result.

So far there has been a "kick the can down the road" or an “extend and pretend” mentality, as borrowers have sought forbearance on loans and lenders have been flexible. That won’t last forever.

“We are waiting for the private markets to unlock,” Torchlight Investors Senior Vice President Angela Johnson said on a recent Bisnow panel. "You have two main reasons why they haven’t: You have this air of compassionate capitalism, so everyone in society is working together to try and figure out how the pandemic will play out, and you’ve had unprecedented levels of stimulus."

Johnson, whose firm invests in real estate debt and acts as a special servicer on billions in commercial loans, said there is stress building on the forbearance side, the bulk of which is in hotel and retail assets.

“At some point, that forbearance will burn off," Johnson said. "We think there is going to be an incredible opportunity, as those work through the system, but it's going to take time. We think it’s not going to really start to work through the system ... until Q2 or Q3 of next year." 

Nationally, the CMBS delinquency rate was almost 9% in the September remittance cycle, according to Trepp. The special servicing rates were over 10%. There were 278 properties backing securitized mortgages in foreclosure as of the week ending Oct. 2, The Wall Street Journal reported.

“We all have sins that we all have to answer for,” Nuveen Real Estate Managing Director Jason Hernandez said. ”On the margin, you will always see distress, even in good times.”

However, his view is that there will not be a mountain of distress coming, and he drew a comparison to the circumstances of this current crisis and the most recent economic downturn of 2008 and 2009.

“You have to compare this cycle to our last cycle ... Last cycle, you had [loan-to-value ratios of] 85% to 95%, you had assets that were over-levered," Hernandez said. "Candidly, you had a financial crisis which drove an increase in risk premiums. What you have today is most lenders were disciplined in the 65% to 75% LTV range.

"On the whole, you are not going to have borrowers that are upside down on their loans," he added. "We haven’t seen risk premiums blow out ...  If this isn't an insolvency crisis that we had last time, I actually don’t think you will see valuation drops, which is going be the trigger for distress."

Meridian Capital Group Senior Executive Managing Director David Schechtman pushed back, saying he expects there to be a “precipitous” drop in values and there will be a larger wave of opportunity than following the events of 2008. 

He noted he is working on a “broken” condominium deal in Brooklyn upon which there is a $65M senior secured mortgage with $25M of equity behind it.

“The sponsors are so pragmatic, they are offering if anyone will give them $5M of their $25M back, they will hand you the keys,” he said.

Ultimately, he predicted it will take five to seven years before there is a return to pre-pandemic values across the board.

“As a general proposition, if you are buying a fee simple property in New York, Chicago or San Francisco, you’d better be in it for at least seven years,” he said.

Certainly, the market in New York City has been experiencing significant shocks. In total, there were 21 investment property transactions over July, August and September in Manhattan, the lowest level of activity since the third quarter of 2009. Residential rents in Manhattan were down 11% last month, and vacancy reached more than 5%, which is a record. 

“Broader speaking, we still have capital, and we still want to deals here in New York, but we want to get paid for taking that risk ... What’s going on in New York with rents falling and distress, we need to get paid, our capital needs to take a commensurate rate of return to take on those perceived risks in New York,” Invesco Real Estate Director Evan Sherman said.

“As a whole, Invesco put out about $8B in capital last year. This year, we’re a little off from our mark but we are doing deals, and we’ve had a lot of interest in the smile states, the states that have favorable tax, the states that have positive inflows of population, where there are jobs and a low cost of living.”

Hernandez said in the short term, what he calls “urban/suburban” office markets are doing well.

“We're looking at opportunities in Atlanta. We are not doing Westchester or Long Island yet, but suburban Philadelphia, Atlanta, Nashville, markets like those traditional urban/suburb markets," he said. "As a short-term trade, those markets will do better.”

Johnson said Torchlight has been lending in places like Phoenix, Raleigh and Tampa in the Class-B and B-plus multifamily marketplace.

“In this environment, we think we can take a construction loan that can’t refinance, we can come and provide our capital, either as a senior or a mezz [lender]," she said. "So we think there are really interesting things to do in multifamily. You got to be focused on the right garden-style [apartment] in the right Sun Belt market.”

Schechtman said he does expect the suburban office market around the city to experience a bump in the coming years, but he doesn’t expect long-term New York City owners to start redirecting their interests out of the city in a meaningful way.

“Families that own 100 or 200, much less 1,000 or 2,000, multifamily units or other assets in New York, unless they are going to be vertically integrated and have a really good third-party manager, [they won't] go pick up 500 units on the 95 corridor down in Florida,” he said. "If you can't reach it by car, you can’t touch it and feel it, inevitably everyone comes home.”