In keeping with the overall economic downturn, the commercial real estate market has not been spared. The last two weeks saw a meaningful fall in transaction volume as sellers delayed bringing assets to the market, while borrowers did not seek refinancing unless under tight timing constraints due to imminent loan maturity. We expect this trend to continue until market conditions stabilize, albeit at a lower level.
While it’s too soon to understand what the longer-term effects will be, the shuttering of non-essential businesses and the reduction in travel has impacted every real estate asset type, but most markedly, the hotel and retail industry. While we see a short-term hit to the multifamily, office, and industrial assets due to business shutdowns and unemployment, we believe these asset types should show a quick recovery as life returns to normal. The shrinking number of new cases of coronavirus in China offers a glimmer of hope that the shutdown in the U.S. should be short-lived.
According to CBRE, following the events of 9/11 and the 2008 financial crisis, it took about two years for rents to go from peak to trough in each instance and then about six years to return to a pre-crash level. However, value recovered more quickly as cap rate compression due to falling inflation/interest rates made up for the slow recovery of rents.
We do not fully know the extent of the current downturn, however, given the market outlook, we expect an economic slowdown for at least the next few months with a slow recovery thereafter. We believe it’s prudent to take a step back and rethink our investment strategy. We’re constantly interfacing with market participants and keeping abreast of macro-economic factors to chase after deals that we believe can perform during a market slowdown.
Over the last few years, the lending market, in particular, has become extremely saturated and competitive. We saw very aggressive underwriting standards to justify the higher leverage loans that became commonplace throughout the market. In addition, the yields kept going down given the competition. The idea that such highly levered loans can perform over the long term was validated by one of the longest bull markets in history. As the economic climate changes, we’re seeing that such loans are on the brink of default and the lenders who had built up a portfolio of aggressive loans stand to face challenging times ahead. While some lenders have shut down shop or hit a pause due to uncertainty, the ones that are active are pursuing less risky deals, while yields have widened significantly across the board.
In light of these developments, we’ve become more selective about the deals that we choose to close—ones that we believe can perform during a market slowdown. We’ve shifted our focus in terms of asset type to multifamily, office, and industrial, targeting core markets that have shown resilience in holding asset value over time. Additionally, we’re only pursuing low leverage loans with stringent loan covenants. We have increased our focus on portfolio management and continue to proactively interact with our origination partners/borrowers regarding potential issues. We will strive to work with our borrowers as issues arise by modifying loan structures to ensure capital preservation.
We believe the market will provide many opportunities for opportunistic investments which we are following closely. As always, we hope to be able to do higher-quality deals with higher yields and provide our investors with what we consider to be best-in-class investment opportunities.
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