If there is any agreement about commercial real estate, it’s that the market is characterized by confusion, conflicting signals and uncertainty about what’s happening at the macro level. That’s why commercial real estate debt could be offering investors attractive opportunities, Marc Weidner, head of portfolio management at Benefit Street Partners, a Franklin-Templeton subsidiary, told attendees today at the Investment & Wealth Institute’s Strategy Forum 2024 in Chicago.
In the decade leading up to 2022, the best way to make money in real estate was to buy an asset, “borrow as much as possible and go home,” Weidner said. That non-volatile environment that prevailed in the low interest-rate era all changed in 2022 when the Federal Reserve began hiking interest rates.
Today, real estate investors are playing in what Weidner described as a “3D matrix.” First, investors need to pick a sector such as data centers or offices. Benefit Street favors multifamily housing.
Second, investors should select a region, Weidner said, adding that his firm likes the U.S. as they “see no premium” from investing abroad.
The final decision revolves around where an investor should put their money within a real project’s capital structure. Benefit Street is clearly trying to convince advisors to consider real estate debt.
The primary reason is that the Fed has raised interest at the fastest pace since the 1980s. In Weidner’s view, the market failed to process the speed and magnitude of the rate rise over a 17-month period and is still struggling to digest the implications.
For investors who could suddenly get a risk-free 5% return on U.S. Treasurys, he said, the result was a “massive repricing” of numerous assets. “The real estate market moves slowly,” he said. The aftermath of the rapid rate rise “is still playing out.”
Then there is the issue of the supply and demand dynamics within the real estate lending market. In many areas, as much as 75% of commercial real loans are supplied by regional and community banks. Many have “more exposure to office,” a notoriously troubled sector, he said.
Weidner said some have little capacity to issue new loans and are largely absent from the market. Meanwhile the nation’s 20 largest banks have been pulling back from the market by choice.
At the same time, loans on a number of high-quality properties are selling at discounted loan-to-value (LTV) ratios. The cost of borrowing is a magnitude higher than it was four or five years ago,” Weidner said.
Indeed, at a presentation the previous day, a representative of another large investment company noted that a loan on the same building in Dallas that was about 5.5% back in 2020 was now yielding more than 11%.
“The opportunity today is to loan [money] at lower LTV than yesterday but also at a spread that is significantly higher,” Weidner said. And the loan quality is also “significantly higher.”
There are other exacerbating factors in his view. A wall of maturities is coming due over the next year or so, but then it drops precipitously.
Moreover, because of the supply-demand dynamics for loans and the scarcity of lenders, Weidner argued companies like Benefit Street can extract better loan covenants and, consequently, earn better risk-adjusted returns.