CRE Analyst

Here are the trends and events that we think will define commercial real estate in 2024.

Crickets… Portfolio manager: “Our lender wants a $100M paydown on a 60% LTV loan?!” Asset manager: “They’re saying we’ll need to rebalance the loan if we want to exercise next month’s extension.” Portfolio manager: “That’s not possible.” Asset manager: “Then we’ll need to sell.” Portfolio manager: “At what pricing?” Asset manager: “20% below our carrying values.” Portfolio manager: “But that will evaporate our promote.” [crickets] Shifting roles… Who were the CRE villains of the last few years? Open-end private funds like BREIT. Many of them continue to block investors from leaving. Institutional core and core plus funds are in a similar position. …on their heels until carrying values fall in line with spot market values. Who were the heroes? Closed-end funds and their dry powder, which many people expect will come off the sidelines, spurring transaction activity and renewed value growth. A new reality emerging... Properties in those open-end vehicles are generally in good shape. They're 90%+ leased and low levered. Values are down because interest rates spiked, but declines have stalled. But rather than coming to save the day, closed-end funds may be shielding problems, and all of that dry powder could be needed for plugging holes instead of opportunistic investing. There may be so many holes to plug--transitional properties, apartments purchased at 3% cap rates, and floating rate debt--that anyone with steady access to capital may soon face some of the best investment vintages in decades. Kudos to StepStone Group for more insightful analysis.

How many college seniors are willing to put 10-15 hours a week into a class that only delivers real estate skills? No certifications. When we launched our FastTrack class five years ago, we thought it would be too much for undergrads. Collin Rock proved us wrong. He was the first undergrad admitted in our very first cohort. We continue to compare every undergrsduate student to Collin. His outsized success was entirely predictable, and we’re thankful to have a front row seat to his progress. Lots of good things to come, Collin. Keep it up!

CRE internship openings… Good news: internships provide unique career onramps. Bad news: most Summer internships are filled by Christmas. These roles are still posted but are scheduled to close in the next few days. ..so apply now if you haven't landed a summer internship. Links below. LinkedIn tends to suppress external links, but please share, comment, or forward to anyone who might be interested. ---------------- Berkshire Research https://lnkd.in/gCCRdD39 Berkshire Investment Management https://lnkd.in/gyggskjw Berkshire Capital Markets https://lnkd.in/eAMm9J3H Berkshire Portfolio/Asset Management https://lnkd.in/gc5sfetM Blackstone Capital Markets https://lnkd.in/g8-YEnED Blackstone Core+ https://lnkd.in/gjzA9x7R Blackstone Asset Management https://lnkd.in/gYS2aJgT Blackstone Acquisitions https://lnkd.in/g-6tRRPa Bridge Investment Group Senior Living https://lnkd.in/gf9_QReV Brookfield Hospitality https://lnkd.in/gBCH4t82 Clarion https://lnkd.in/gnYUjZ4d Greystar Investments https://lnkd.in/gtmZ6ywe Greystar Development https://lnkd.in/gPw23TFC KKR Client Solutions https://lnkd.in/gGE_5BNK KKR Capstone https://lnkd.in/ggB7uac4 KKR Infrastructure https://lnkd.in/gTt93kUM LBA Realty https://lnkd.in/gtn8gqjk Starwood Asset Management https://lnkd.in/gtcqA2Mf Starwood Capital Hotel Asset Management https://lnkd.in/gDQJ-aPE StepStone Private Equity, Infrastructure & Real Assets https://lnkd.in/gcJq-yNi TA Realty https://lnkd.in/epQdxSV9

This distress indicator suggests: 1) more pain to come, 2) no one is immune, and 3) more multifamily problems than any other sector. ---- What triggers loan defaults? ---- Commercial mortgage defaults generally occur (i) when property values fall below the outstanding loan amount AND there's a loan maturity or (ii) when debt service exceeds property income. In other words, challenging LTVs drive defaults at maturity, and challenging DSCRs drive defaults over loan terms. Pundits who estimate distress often focus on LTV-based defaults because we have relatively good data on property values (at least property value estimates) and on loan maturities. But maybe they're missing something by not focusing on DSCRs. ---- Institutional properties not covering debt service ---- The NCREIF Property Index is one of the most frequently tracked industry indicators because it reflects institutional properties and goes back 40+ years, providing a unique historical perspective. On balance, these institutional properties are 90%+ leased and 42% leveraged. On the LTV side of the NPI, office leads distress (as measured by underwater loans), but on the DSCR side, multifamily leads the industry. i.e., institutions have more multifamily properties that can't cover debt service than any other property type, including office. StepStone recently highlighted: "Coverage ratios are also deteriorating. Multifamily represents the greatest share. Unlike post GFC era, declining rates are not likely to solve the problem..." This brings up a few important questions: 1) If institutions with 40% LTV properties aren't covering, what does this say about more levered owners who borrowed at 60-75%? 2) How long are they willing to feed these properties before selling them or giving them back to lenders? TLDR, don't sleep on the magnitude of multifamily challenges that could emerge.

What's better than dry powder? Cheap equity. Cheap, plentiful, and consistent debt. And sidelined competitors. ---- REITs rising ---- Pubicly-traded REITs haven't been big buyers since the GFC. They couldn't compete with heavily levered private equity with 0% ish debt. But the tables have turned. ---- Not all REITs ---- NAREIT says there are about 225 publicly traded REITs. Of these, there are 100 or so legit REITs listed on major exchanges. And of these, 21 seem to be in a position to go on the acquisition offensive. These 21 REITs represent about $625 billion of equity market capitalization. Assuming they grow by 10% in the next few years and leverage their equity 1/1, that's about $125 billion of acquisitions, which is needle-moving in a $300-400 billion-a-year market. Two big questions... 1. Which REITs will lead the charge? 2. Will transaction activity be driven by M&A or one-off?

Explain this chart... 1) Good things come to those who wait. 2) The rich get richer. 3) Hurry up and retire already! 4) They're all paid well, who cares? 5) Small sample size skews the results. This dataset summarizes 2023 compensation for the 25 highest-paid REIT executives by age. A few observations... Average comp: $18 million. Average age: 60. Distribution: There are more highly-paid REIT execs in their 70s and 80s than in their 40s.

Does this make brokers more valuable or less valuable? Backstory: DealPath has standardized the deal pipeline process within buyer organizations. JLL has agreed to feed properties, when they are listed for sale, directly into DealPath for DealPath clients.

10 trends that defined private equity markets in 2024... CRE capital doesn't exist in a vacuum. Traditional private equity competes with real estate for capital but is subject to some of the same gravitational pull as real estate. Here are 10 trends that defined private equity markets in 2024. How many of these define today's real estate markets? 1. Decline in Deal Activity Private equity deal values dropped 37% in 2023 to $438 billion, the lowest since 2016. Exit values fell even further, declining 44% year-over-year. 2. Fundraising Contraction Total private equity fundraising fell 20% in 2023, with fewer funds closing compared to prior years. However, larger, more established funds attracted the majority of capital, with the top 20 buyout funds accounting for over 50% of the capital raised. 3. Dry Powder Accumulation Global dry powder reached $3.2 trillion, with 26% of buyout dry powder now four years old or older. This growing inventory of unspent capital is creating pressure to deploy funds despite challenging market conditions. 4. Shift in Debt Markets Private credit gained market share, accounting for 84% of middle-market leveraged buyouts as traditional banks pulled back. 5. Sector Trends Technology continues to get more of the equity, but traditional industries such as industrial goods gained share as investors sought stability. Growth and venture capital segments continued to decline. 6. Exit Challenges Exit activity declined sharply, with global buyout-backed exits totaling $345 billion, down 44% from 2022. Corporate buyers, the largest exit channel, reduced activity due to macroeconomic uncertainty. IPO exits showed modest improvement but accounted for only 3% of total exit value, reflecting subdued public market activity. Secondaries fundraising grew 92%, driven by demand for liquidity solutions such as continuation funds. 7. Liquidity Constraints for LPs Slower distributions and higher drawdowns left many LPs cash flow negative, limiting their ability to allocate fresh capital to private equity. 8. Operational Value Creation GPs are being pushed to focus on organic growth and operational improvements to drive EBITDA growth, as multiple expansion becomes less viable in the current environment. 9. Buy-and-Build Strategies Expand Add-on acquisitions and bolt-on strategies increased in importance as a means to drive growth within portfolio companies. 10. Pressure to Innovate GPs are exploring novel approaches to liquidity and value creation to address rising refinancing needs and exit constraints.

Four quick takeaways from Ares on emerging market opportunities... 1. Focus on alternatives -- Global alternatives market: $220T ($140T institutional, $80T retail) -- Private equity growing 10% YoY -- Private credit growing 11% YoY -- Real assets (CRE/infrastructure) growing 7% YoY -- Secondaries growing 9% YoY 2. Retail investor channels -- Pool of capital from investors with $1M of retail investments to grow from $80T to $100T over next four years. -- Retail investors' allocation to alternatives to go from 3% to 6% -- High net worth segment to grow from $3T to $13T by 2032 3. Shrinking banks -- $12T question: how much of bank loans will find a new home? -- Banks under pressure (cost structure and short horizons) -- Number of banks shrinks from 14K to 4K (and falling) -- C&I loans were 29% of bank loans in 1982 vs. 16% in 2023 -- Private credit has grown 14%+ YoY for last 10 years -- Private credit dry powder is a small fraction of private equity dry powder 4. Haves vs. have nots -- Top 25 investment managers control 56% of market (up from 39%) -- 4 of the largest 6 managers control 52% of semi-liquid market -- 115 platform acquisitions by largest 50 managers since 2012 (See section that starts on slide 17.)