Thirty Capital recently held a virtual roundtable highlighting today’s shifting commercial real estate (CRE) market and how it’s redefining asset, debt, and equity management. Anne Hollander, Thirty Capital’s Chief Strategy Officer, had the pleasure of speaking with Carolyn Pianin, Head of Asset Management at Lightstone Group, and Alex Gottlieb, Senior Associate at Verus Commercial Real Estate Finance.
Click here to watch the on-demand recording or read ahead for a recap of their conversation and key takeaways.
The Recalibration of CRE
Thinking about CRE in terms of market cycles, the last cycle was a decade long and managers were proactive, engaged, and a good steward to investors. With regards to the current cycle, the panelists touched on a couple of key observations related to property value, leverage, cap rates, and lending rates.
Across the board, property values for multifamily, industrial, and hotel are beginning to see headwinds. Despite conservative underwritings, decreasing property values, and increasing cap rates, there are some instances in hospitality where properties have decreasing cap rates to align with their value. There’s an even larger dip in office building valuations, which can be attributed to businesses transitioning to or expanding remote work, as well as the lingering impacts Covid-19 had on unemployment.
With all of these shifts in the market and that ever-impending recession, how can CRE firms adjust their strategies and ensure that they are able to protect cashflow? The panelists shared a few tips and scenarios that they have experienced.
- Firms are beginning to forecast cashflow more frequently than they may have previously done to account for market uncertainty as it continues to unfold. This strategy helps ensure they continue shifting with the market and not because of it.
- There’s an increase in management and education coming into managing near-term loan maturities, particularly in the mid-market space, to ensure firms are knowledgeable about all available options and the best path moving forward.
- Firms are doing a better job of communicating with investors as they ask for more information and visibility into operations and finances. Many firms are leveraging third-party platforms to improve reporting efficiencies while providing deeper and faster reporting and insights.
- There’s a shift in proactively understanding and navigating loan covenants as firms meet revenue expectations but face increasingly higher costs. This opens the door for potential loan covenant violations if they have a liquidity / net worth problem and need to extend their loan.
- The slow down in acquisitions and the potential need for additional equity creates a need for an optimized cashflow strategy and ensuring you have your hands around existing assets. As property values decrease, costs increase, and loan maturities approach, firms need to closely monitor and assess asset-specific levers to protect cashflow and realize the highest possible return.
Aligning the Three Pillars of Cashflow Management
Pillar #1: Asset Management
“We’re All Asset Managers at the Moment”
Asset management is in the spotlight as growth slows and operational expenses rise. There’s a consensus that “we’re all asset managers at the moment” as acquisitions and growth slows, putting more emphasis on managing and protecting existing assets. Income has continued to grow into 2021 and 2022; however, expenses are outpacing revenue growth across the board. From the expense side of things, there’s been a huge spike in insurance and payroll costs, which puts a larger emphasis on keeping cash available to cover debt services and rising interest rates.
Providing an example of increasing expenses, multifamily properties in Florida and Texas were heavily impacted by recent policies set in place that allow insurance companies to raise premiums at their discretion. Property owners are now faced with raising rent slightly higher than they had planned and creating uncertainty as to whether the market and its tenants will tolerate it.
“What’s My Valuation Today?”
Asset managers, lenders, servicers, and others would historically want to know a property’s valuation on an annual basis. It is now becoming necessary to calculate more frequently to ensure they’re staying up to date with what’s happening in the market. Increased frequency also ensures that any updates or changes they plan on making will actually drive valuation. It was noted that when you have a decline in sales comps, it makes it difficult to find accurate, real-time data given appraisals are backward-looking and the market is amid a recalibration where the status quo is being rewritten.
“Is It Me or the Market?”
Circling back to our insurance example in Florida and Texas, there may be market-specific factors that are impacting one property and not another. The question of, “Is it me or the market?” puts emphasis on discovery and talking to as many people as possible to get a broader understanding of what is happening across the market and sub-market. Additionally, leveraging market benchmarks specific to a location and property type adds an additional layer of context that goes beyond the portfolio.
Pillar #2: Debt Management
The Debt Wall is Coming
With $1.5T in maturities coming due in the next three years, we’re already seeing an increase in loan delinquency (up 12 basis points in Q1 of 2023). Lenders and servicers are trying to mitigate this by requesting more reporting and insights. Some lender owners and operators are even sending team members to discreetly walk the premises of properties to get a better understanding of what is going on.
While it’s not ideal for the borrower to hand over the keys to their building, there is a silver lining for the greater market in the current cycle. We’re now getting more clarity around property valuations as lenders begin selling off their reclaimed assets.
Trend Watch – The Rise of Debt Management
Over the next 18 months, we’ll see the following loan maturities:
- $20.6B in multifamily
- $17.2B in retail
- $12.4B in office
- $4.8B in hospitality
Source: Freddie Mac CMBS, Trepp
In the grand scheme of things, multifamily is relatively safe given demand and the need for somewhere to live. However, there’s a high level of concern around office buildings, even with it being third in line. It was noted that the weighted average lease term is seven years and the average commercial real estate cycle is seven years, which causes owners to be locked up in a bad cycle.
Managing Investor Relations
Now more than ever, maintaining healthy investor relations is critical among borrowers, as frequent communication helps build trust between the two parties. Lenders encourage borrowers to be transparent about any mishaps or shortcomings rather than let them boil up as an unwanted surprise. There’s much more room for negotiation when one party isn’t blindsided at an inopportune time, such as underwriting.
Pillar #3: Equity Management
Investors are getting nervous and asking questions as the current cycle challenges historical returns and the risk associated with investments. They want more granular information and want to know if things are stable and, if not, what’s being done to fix them. The need to set new expectations and quickly communicate any bad news is extremely important from a relationship-management standpoint. Taking the asset, debt, and equity into a singular view, it’s important to understand what’s driving changes, what those impacts are, and then communicating them back out to investors.
With the three pillars (asset, debt, and equity) driving/impacting cashflow, it’s important to analyze and stress test how changes to one impacts the other. What may be the solution to one asset may not be true for another. Now more than ever, we must think beyond the building and ask the question, “Is it me or the market?”
Want to learn about these topics in more detail? Click to watch or bookmark the on-demand webinar below!