Capital Markets Remain Slow As Investors Still Afraid ‘To Catch A Falling Knife’

Lenders and investors are playing a waiting game, and it’s anybody’s guess when time will be up. 

As banks hold on tight to the lending reins amid hostile macroeconomic conditions, a pile of money has been raised to take advantage of discounts in the market. Experts say it is only a matter of time before the dam breaks, but the question is: Who will take the first leap?

“That’s why so much money is sitting on the sidelines. Nobody wants to catch a falling knife,” Red Oak Capital CEO Gary Bechtel said at Bisnow’s DMV Capital Markets event on Sept. 21, held at the Westin City Center. 

The slow-moving capital stream was top of mind for panelists as they discussed the barriers to lending and speculated about when activity will ramp up for distressed office deals.

“I’ll be honest: Our volume will be down this year versus last year,” Nuveen Real Estate Head of Real Estate Debt for the Americas Jason Hernandez said. “And it's not because I wanted to. There's less transaction activity, and there's just less liquidity. We're not creating capacity in the system.”

Nationally, transaction volume has been down year-over-year since January, according to an MSCI report released Wednesday, with the majority of months down more than 50% from the year prior. In August, volume was down 60% year-over-year, according to the report. Thursday’s panelists confirmed they are seeing the same trend on the ground. 

“Transaction activity is slow for us, slower than we’d thought it would be, slower than we’d like it to be,” said Artemis Real Estate Partners principal Michael Vu, whose firm raised $2.2B this year for a fund focused in part on investing in distressed real estate. 

In D.C., commercial real estate investment volume was $353M during the first half of 2023, less than a quarter of the average volume seen over the previous four years, according to Avison Young’s second-quarter office market report. 

Cortland Chief Investment Officer Mike Altman said taking it slow is the smart play. 

“Banks and lenders shouldn’t be financing new deals,” he said. “This is a time to pause that part of our business.”

But while much of the financing is stalled, billions of dollars are piling up on the sidelines, raised with the intent of purchasing office properties at a steep discount. The problem is, nobody knows how far prices will fall. 

Companies like Cohen & Steers, Goldman Sachs, EQT Exeter and BGO are among the companies raising billions to purchase distressed office assets on the cheap, The Wall Street Journal reported last month.

In D.C., Avison Young’s Q2 office report predicts “increased activity in distressed sales” moving forward. 

“No one knows where the bottom is for D.C. office,” Bernstein Management Corp. CEO Joshua Bernstein said. “I think we're looking at sales that will go below $100 a foot. I think you're looking at mid-block big buildings where there will be parks, and I don't see uses for a lot of the particularly older office in D.C.” 

The problem is how low the assets should be priced? Where can investors safely catch the figurative falling knife and allow the feeding frenzy to begin? 

Hernandez argued that estimating valuations is possible, but nobody wants to jump on them.

“You can throw up your hands and say, ‘Holy crow, I don't know what it's worth.’ No, actually, I think we do, right?” he said. “If you look at the open-end core funds, ...  the write-downs in the office space, and you can [estimate] 25% to 30% of that across the board. So I think people are looking for a proxy to the spotlight.”

Panelists said that lenders are watching the big players — the Blackstones and REITs of the world — to see when they pounce.

“Much of our market really is based on herd behavior,” Ackman-Ziff Managing Director David Borden said, adding that once the large funds start jumping in, some smaller players will have the confidence to follow suit.

“You have a number of folks who are going to [negotiate loan agreements] but have no data points. And once they do and they can say, ‘OK Blackstone or Nuveen or whoever it may be from a large, institutional perspective and large data aggregators have actually deployed,’ you can have some confidence in penciling and not necessarily taking your lone wolf scenario,” he said.

Fortress Investment Group took the bet on a New York City office portfolio in August, purchasing $1B in loans from Capital One. 

“When you see more of that and you see more loan sales and more people understanding where the bottom is, people will start to jump in,” Wells Fargo Managing Director of Specialty Real Estate Rachel Goldin Jinich said.

She said deals like that will help banks like Wells Fargo with “sticky” office exposure on their books begin to increase their deal flow.

“We have a huge office book that we’re looking to reduce," she said. 

“The more we move things off balance sheets, whether it's through debt funds, whether it's through the capital markets, seeing life companies step up, that's going to help, right, just to free up capacity and finding other places to place the capital,” she added. 

When it comes to placing that capital elsewhere, banks are being extra judicious about where the money goes and how it is being used to ensure dollars stretch as far as they can, Goldin Jinich said. 

“Every bank, whether you’re a small bank, a regional bank, a larger bank like Wells Fargo, we all have to be more thoughtful and strategic about where we put that capital,” she said, adding Wells Fargo is “very selective on sponsorship.”  

“Right now, credit needs to be pretty pristine because you have only so much capital to put out. There’s a lot more demand for capital than there is capital to put out,” Goldin Jinich said. 

But even once that financing is in hand, barriers to deploying it still permeate. 

“There’s more fear of being wrong than there is a number that people are actually going to trade at,” Fundrise co-founder Brandon Jenkins said.