How Debt Funds Are Reshaping the CRE Capital Markets
After the last two years of falling CRE transactions and property valuations, markets are starting to come back. BlackRock Real Estate Research said that it’s time to invest. SL Green Realty has a $1 billion opportunity debt vehicle. RXR and Ares Management formed a $1 billion fund to buy distressed office assets. Goldman Sachs formed a $2.6 billion fund for CRE lending.
Notice the amount of interest in CRE debt—it’s there for a reason. The Mortgage Bankers Association estimates there is $929 billion in loans coming to maturity this year alone, a 28 percent increase from 2023. That sum is a fifth of the $4.7 trillion of outstanding commercial mortgages held by lenders and investors and includes many property owners who will need to refinance, sell, or even turn keys back to lenders.
Banks can’t take on their usual role in CRE lending over concerns about the current state of their portfolios. “Credit quality at banks remained strong, although the quality of CRE loans backed by office, retail, and multifamily buildings continued its decline, as a result of the lower demand for downtown real estate prompted by the shift toward telework,” the Federal Reserve wrote in its Monetary Policy Report of March 2024. “Some smaller regional and community banks with high concentrations of CRE loans are also highly reliant on uninsured deposits, potentially compounding vulnerabilities.” The more compromised assets seem to be, the closer the banks come to last year’s fate of Silicon Valley, First Republic, and Signature.
Redefining the capital markets
Fortunately, alternative sources of financing offer other options, though terms and conditions vary widely. Insurance companies look to lend on the lower end of the leverage scale—55 percent to 60 percent LTVs. Debt funds and REITs typically will price at several hundred basis points above SOFR. CMBS is around 7 percent on new loans.
Rates significantly above what banks would normally charge, depending on the source and perceived risk, are more of a challenge. And yet, two significant benefits from such sources often offset the extra cost. First, and most important, is the ability to find financing when banks won’t talk, enabling the ability to do business. The other benefit is speed. Borrowers can sometimes strike a deal and get financing in a matter of a few weeks.
When looking at alternative financing, be smart and be sure that the financing you get won’t trip you in the end. Be realistic in models, pro formas, and scenario planning. See what a proposed deal needs in reality. Avoid overly optimistic projections that could lead to a no-win situation. But recognize, too, that any rate cuts the Fed makes will be limited this year. Even three reductions would likely bring only a total 75-basis point drop—nothing to dismiss, and yet no startling improvement.
Waiting might be the best choice. However, remember opportunity cost. Tight financing conditions might make possible a transaction that will eventually pay off handsomely and “saving” money could come with an even larger price.
Jonathan Hipp is principal of Capital Markets & head of U.S. Net Lease Group at Avison Young.
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