Well-timed greed is a long-standing American tradition.
Warren Buffett is famous for saying, “Be fearful when others are greedy, and be greedy when others are fearful.” But before Buffett, there was J. Paul Getty, an oil tycoon and the patriarch of the Getty family who got his start buying shares of distressed oil companies during the Great Depression. And in the aftermath of the mortgage meltdown of 2008, while foreclosures were piling up, a new generation of well-capitalized players — from Blackstone to Steve Mnuchin — made their fortunes diving into troubled waters.
Blackstone helped create the institutional single-family rental industry by hoovering up homes at foreclosure auctions via Invitation Homes, resulting in a $7 billion profit after the company went public in 2017. Mnuchin, before he was Donald Trump’s Treasury Secretary, led a group of investors, including billionaire financiers George Soros and John Paulson, to double their money rescuing failed bank IndyMac at the height of the meltdown in 2009.
When the coronavirus brought the world to a standstill in 2020, private-equity firms and other cash-rich investors geared up for yet another once-in-a-generation shopping spree, this time focused on commercial real estate. Instead, they faced years of rapidly changing market dynamics that stymied distressed dealmaking.
Now, nearly four years later, institutional investors are finally starting to pounce, including with deals to buy troubled real-estate loans from failed regional banks. Blackstone and Mnuchin are both in the game of bidding for heavily discounted assets. It’s led to a wave of dealmaking that suggests the commercial real-estate crash may soon bottom — if it hasn’t already.
“We believe that real-estate values are bottoming,” said Blackstone’s President and COO Jonathan Gray during the company’s January earnings call.
He is not alone: Jim Garman, Goldman Sach Asset Managements head of real estate, told Reuters last week that his firm is ready to start “actively investing” in commercial real estate because “the market is bottoming out.” Trading in commercial mortgage-backed securities and the sale of stakes in illiquid real-estate funds suggest other large investors see the bottom, too.
That’s not to say predictions of a commercial real estate rebound are a sure bet. The sector is still poised for pain, especially when it comes to office buildings, which continue to suffer from the work-from-home phenomenon. In January, billionaire Starwood CEO Barry Sternlicht said he sees office property losses hitting $1 trillion.
But as Gray said in January, calling a bottom is not for the faint of heart. There’s no “waiting for the all-clear sign,” Gray explained. Doing so would mean missing the opportunity because “the best investments are made during times of uncertainty.”
Here are four signs that support Gray’s prediction that the commercial real estate market may be bottoming.
Commercial mortgage-backed securities
According to Tracy Chen, a portfolio manager at Brandywine Global, commercial mortgage-backed securities, also known as CMBS, are a leading indicator for the commercial real estate market because CMBS trades more frequently than the buildings they’re tied to. According to Chen, this opaque market of securitized loans backed by offices, apartment complexes, and other CRE properties is starting to show signs of a recovery.
After a rough 18 months that drew interest from short sellers, prices for CMBS have been rising, thanks to expectations that the Federal Reserve will start cutting interest rates this year.
“The number of cuts from the Fed doesn’t matter anymore. It is more the directional signal it sends if they cut,” said Chen, who invests in securitized debt for the firm, which manages $46.8 billion in fixed-income investments.
The biggest risk for commercial real estate — and CMBS investors by proxy — is if the Fed does not cut interest rates at all this year, Chen said. That would lead to more uncertainty and challenges for properties that need to refinance.
Bank deals
Chaos in regional banking has been both an indicator of and contributor to commercial real-estate distress because these smaller banks are the largest lenders to the sector. But now, large investors — some of whom made money in the last crisis — are diving into the troubled waters of regional banks via deals that suggest growing confidence in select commercial property markets.
Earlier this month, Mnuchin led a group of investors who invested over $1 billion into the struggling New York Community Bank. The bank’s stock price plummeted nearly 70% this year after the firm found “material weaknesses” in how it looks at loan risks, resulting in cuts to its dividend.
The Hicksville, New York, bank is a huge lender to New York area commercial real estate, and Mnuchin’s investment is a vote of confidence in the bank’s ability to ride out the current storm.
The regional bank crisis has also opened the door to large investors buying loans backed by real estate for pennies on the dollar. At the end of last year, the FDIC auctioned off $60 billion worth of loans backed by real estate it had held since the failure of Signature Bank in March 2023. (New York Community Bank had previously purchased $2.7 billion in Signature’s loans and deposits, but not the real estate loans.)
The winners of the auction included Related Fund Management and affordability housing nonprofit Community Preservation, which purchased a 5% share of a $5.8 billion Signature portfolio in multifamily assets, 80% of which are rent-regulated and very challenged by New York’s restrictive 2019 rent laws, for 59 cents on the dollar, according to the Commercial Observer. The rest of the portfolio will remain owned by the FDIC.
Two Blackstone funds, BREIT and Blackstone Real Estate Debt Strategies, led a joint venture that acquired 20% of a $16.8 billion book of Signature commercial real estate loans largely focused on non-rent-regulated multifamily, retail, and office for a purchase price of $1.2 billion. This implies a purchase price of 72 cents on the dollar. Blackstone has been busy, shopping around a $1.8 billion slice of the portfolio, and it has already sold off $247 million in loans.
Spanish banking giant Santander’s US subsidiary acquired a 20% equity stake in a joint venture that services a $9 billion book of Signature loans backed by rent-regulated multifamily for $1.1 billion, which implied a purchase price of 60 cents on the dollar.
Single-family rental dealmaking
At the beginning of this year, Blackstone made a deal to take single-family rental company Tricon private in a $3.5 billion equity transaction, representing a 30% premium on its share price.
The deal came after Tricon’s stock price had fallen almost 60% from early 2022 to the fourth quarter of last year, versus dips of closer to 30% at peer companies like American Homes 4 Rent and Invitation Homes. Blackstone has also agreed to pump $1 billion into the company’s existing homes.
It’s the most significant deal for single-family rentals since interest rates started rising in 2022, and it suggests that this market may be starting to thaw. (Other signs of a thaw include JPMorgan’s $770 million credit line to Fundrise to develop new communities, announced earlier this month, and Sun Life’s real estate manager, BGO, announcing that it would buy $500 million worth of homes without using debt to make the purchase.)
Before interest rates rose, there was arguably no hotter market than rental homes. Investors raised $110 billion by late 2022 to deploy into the asset as home affordability woes suggest more Americans will be renting for longer.
Data centers are another buzzy asset class that could take off if there is indeed a bottom to the commercial real estate industry’s woes. At the end of 2023, Blackstone announced a $7 billion deal with Digital Realty to develop four “hyperscale” data center campuses.
Real estate secondaries
There’s also been growing demand for commercial real estate exposure through what’s known as the secondary market, where holders of illiquid assets, like interests in private-equity funds, can sell their stakes.
Deal volume for secondary market transactions tied to real estate funds fell 21% in 2023, according to data site Secondaries Investor, even though many deals were at a major discount to their underlying values.
But interest appears to be ticking up again in the form of fundraising. At the end of last year, Blackstone and Ares each closed multibillion-dollar real estate secondary funds, at $2.6 billion and $3.3 billion, respectively.
Brian King, CEO of secondary market Lodas, says he expects some recent fundraising to be deployed into troubled REITs.
The spate of redemption requests in the private REIT market, combined with the challenges facing some underlying assets, has caused some REITs to trade at 50% below the value of all of their assets.
That has prompted some large investors to offer loans that could allow them to take over the underlying real estate if the REITs fail, King said.
According to David Seifert, partner at private equity real estate firm Velocis, there are some sweet deals to be had in secondary sales of private-equity funds tied to real estate. Seifert said his firm was able to make some secondary acquisitions last year at discounts of around 50%.
For many of those deals, Velocis was the only interested buyer, Seifert said, but he sees secondary transactions around real estate funds to ramp up the Fed gears up to cut interest rates.
“I expect the big boys to be more active,” he said, referring to the Blackstones and Goldman Sachs’ of the space.
The road ahead
Where Gray sees signs of bottoming, others think commercial real estate has much further to fall.
Dan McNamara, chief investment officer at Polpo Capital, which has both short and long positions on securitized real estate debt, says that he expects a hard landing to be more likely and that continued regional bank chaos could stand in the way of a broader CRE recovery.
“Regional banks have dealt with interest rate issues but haven’t dealt with their credit issues regarding commercial real estate,” McNamara said.
RXR Realty CEO Scott Rechler wrote in a recent white paper that he expects the US to lose 500 banks, or one in every eight banks, over the next two years to bank failures and consolidation.
For Rechler, the “slow-moving train wreck” of maturing commercial real estate loans will wallop many of these banks and could even be a systemic risk to the US economy, though Janet Yellen said last month that she “hopes and believes” the issue isn’t a systemic risk.
In this scenario, the real buying opportunity may be down the road. Rechler wrote that current issues may be “more structural in nature” and pointed to the savings and loans crisis of the 1980s and 1990s, which put nearly 3,000 banks out of business and led to a “reset” in both capital structures and valuation.
In the CMBS market, McNamara believes there’s a “tremendous” amount of opportunity ahead and large amounts of risk. In other words, tread carefully because for every fortune to be made shirts will be lost.
“The market today can best be described as adult-swim only,” McNamara said.
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