Double Down or Duck Out

For Team YazLee and the entire world, what started as a week of uncertainty in health, capital markets, and society as we know it, ended with a government mandate that placed the 5th largest economy in the world on total lockdown. The ramifications of that statement for the future of our lives are almost impossible to envision yet we believe in humanities ability to innovate and preserver.

Future Uncertain:

Below is a snapshot of Los Angeles traffic as of 9:15 on Monday 3/23/2020. As lifelong natives and recent converts, we are accustomed to viewing the pigment of RED as a gauge of productivity.

Perhaps for once, green did not mean go. This map signifies the shutdown of a $3+ trillion economy, 5th in a list that consists of 1) the entire United States 2) China 3) Japan and 4) Germany. California has already lost $43 billion of economic productivity due to the lockdown, with 190,000 new applications filing for unemployment.

Providentially, the economy has not stopped completely. Yet, on a macro scale estimates are predicting the largest quarterly contraction in history (Goldman Sachs the most pessimistic with a – 24% decline forecast). Most impacted are the hotel, retail, and entertainment industries. Examples include an estimated 55,000 flights canceled in the coming months and an expected 4 million hospitality employees losing their jobs – Ashford Inc Lays off 95% of its 7,000 workers. A new question has arisen: How long will the United States dictate a lockdown throughout this market turbulence?

The impact of this shutdown on Commercial Real Estate has been profound. Still, we are not in a complete credit crunch – a period with a sudden reduction in the availability of loans – for CRE assets. Through dozens of conference calls with all types of capital providers, GSP is confident that capital and the appetite for CRE investment persists.

Market Updates:

Asset Classes

• Industrial and Multifamily are actively being pursued.
• Office is being reevaluated as capital providers discuss the future of the workplace.
• Retail has gone from scrutinized, to only if accompanied by multifamily or office.
• Hotel loans are at a complete standstill.
• Specialty assets such as self-storage is looked at favorably if there is a rental component.

CMBS – Verdict: Ducked Out

The status of CMBS in comparison to 3 months ago cannot be sugar coated. Last week we mentioned that the Triple A (AAA) market widened significantly from 70 bps above the 10-year swap to 175 bps. Here are updates from last week:

• All in pricing over 4%.
• Indication that the AAA’s are in excess of 250 bps. Maybe More.
• Accordion effect:

If the risk premium on AAA’s (the most secure part of a hypothecated loan) increased by nearly 400% in 2 weeks; the B piece has done so in an even more exaggerated degree.

The B piece which is sold to a select group of risk tolerant buyers was expected to widen to over 800 bps above the 10 year – as of last week that translates to 9% interest.

Shockingly the singular loan pool that was set to price last week at these levels received 0 interest and was pulled from the market – maybe they knew something the general public did not .

Note loans in a standard CMBS pool average sub 65%.

• This market depends exclusively on bond buyers.

Historically the B buyers dictated if a pool could be sold.

Today even the AAA’s have a limited buyer pool

• CMBS seeks information from CMBX (commercial mortgage backed indexes) which on Monday saw the most limited activity in years.
• This market depends on how a new pool will trade 

Reliance on CLO Markets – Verdict: Ducked Out

Similarly, to CMBS the CLO market which provides higher risk floating rate bridge and construction capital has almost shut down completely. These lenders depend on a secondary buyer to purchase loans after they are issued to borrowers. With no buyers to guarantee pricing these institutions are on the sidelines indefinitely.

Fannie & Freddie – Verdict: Double Down but Backed Up

Fully supported by the US Government, Fannie Mae and Freddie are positioned as an unstoppable force designed to stabilize multifamily lending markets. As discussed last week, the hesitance of these agencies to issue new DUS licenses is showing major repercussions. The agencies are incredibly backed up across the board and the reliance on the secondary market is causing spreads to blow out tremendously.

• In February of 2020 GSP closed a 65% full term IO loan at sub 3%
• Today a similar asset is pricing in the low 4’s with turnaround time

LifeCos – Verdict: Double Down

Life Insurance Companies evaluate risk through the largest binoculars. Naturally this allows these types of capital providers to exit the market or lag in their affirmation of placing capital. Yet, GSP has obtained various quotes for 65% leverage on quality assets at or below 4% in the last week. After further investigation, these quotes are validated and supported. In our conversations, despite a low risk tolerance, the need to meet returns/pay out policies trumps the global set back.

Foreign National Banks, Debt Funds, and Commercial Banks – Verdict: Double Down 

“This is the best opportunity to increase market share since 2009 and we are far better capitalized,” one bridge lender told our team as of Friday last week, “we stopped quoting for a week and a half as the dust settled but after reviewing our balance sheet and digesting the feedback, we are fully capable of putting out massive amounts of capital.”

Since March 16th, GSP is most encouraged by the groups who view the COVID-19 era as an opportunity to buy into a reset market. Many foreign national banks and a select group of US banks view US Real Estate as the safest global asset, along with well capitalized debt funds and commercial banks reallocation of risk.

(Note: candidly we have seen about 50% of these capital providers reaffirm their commitment to place capital)

• Foreign National Banks – Rates are stable or reduced commensurate with costs of capital
• Debt Funds – Bridge and construction products have increased by 100-150 bps

Best assets: All in of 4.5%

Higher leverage more risky non-recourse investment: Remains below 10%

• Commercial Banks – More stringent UW policies with spreads holding steady

Innovation:

The COVID-19 era is forcing our world to adapt more rapidly than ever before. However, in comparison to previous economic shifts, we now have the tools to innovate more expeditiously then in any generation’s past. In other words: Green Means Go.

The GSP work-space as example has changed through the rapid implementation of virtual meetings, enhanced integration of communication software, and an array of other technologies that allow us to service our clients. Commercial Real Estate as a whole is a notorious laggard to other fast-paced financial industries, yet it’s better equipped to begin embracing many of these changes. Co-working and co-living, lifestyle centers, property tech, and digital capital, are all aspects of CRE which came to the forefront post the great recession. While the shift may be jarring, it is already recognized, and capital providers have responded accordingly.

Thank You and Reach Out

It goes without saying that we are in trying times due to the COVID-19 pandemic. Team YazLee remains very optimistic that amongst this uncertainty there is amazing opportunity for our clients and industry. We are reassured in our belief that US CRE will remain a top asset class across the globe. While the dynamic may shift we will adapt and provide real time feedback.