In a transaction market that remains relatively quiet, a few investors made some big moves when it comes to buying distressed commercial real estate debt.
In Mid-August, Fortress Investment Group acquired roughly $1 billion in office loans from Capital One that are backed predominantly by assets in New York City. And in June, Kennedy-Wilson Holdings acquired PacWest Bancorp’s construction loan portfolio and lending platform for $5.7 billion.
There is a significant amount of capital in the market targeting distressed commercial real estate loan portfolios, both in terms of new capital being raised as well as investors sitting on funds that are shifting their focus from equity to debt. “It doesn’t feel like there is a lack of capital in the system, the question is more on the pricing of risk,” said Matt Windisch, executive vice president at Beverly Hills-based Kennedy-Wilson.
The PacWest construction loan portfolio acquisition was an opportunity that arose out of Kennedy-Wilson’s longstanding relationship with PacWest, according to Windisch. PacWest was in a position where they needed to sell assets to generate liquidity. Because it was a construction loan portfolio, roughly half of the balance was funded and the other half was unfunded. “It made sense for them to find a buyer to get cash in the door and get out of the future funding obligations for those loans,” noted Windisch. The added liquidity also helped PacWest work out a merger with the Banc of California.
Kennedy-Wilson is planning on leveraging the acquisition to grow its lending business. In addition to doubling the size of its debt book, the acquisition included the PacWest’s construction lending platform that will allow Kennedy to service and originate loans, therefore expanding its existing bridge lending business to also include construction lending. “We liked the pricing, and we think we’re going to get a good return, but we also were able to get the team and we think there is a great runway to grow the portfolio over the next couple of years,” Windisch said. The portfolio of loans was primarily backed by multifamily and student housing, with some hospitality and industrial and no office.
Dry Powder is Ready to Pounce
The two mega-deals shine a spotlight on what is expected to be a growing pipeline of distressed real estate loan portfolios coming to the sales market, particularly from the large money center banks and the larger regional banks. “The expectation is that many of the investors targeting this debt feel that banks specifically will be larger market sellers due to the expected increase in regulatory pressure,” said Sean Ryan, a senior managing director at JLL Capital Markets and co-head of the firm’s loan sale platform. Banks are cleaning up balance sheets and bifurcating between core and non-core customers, which is expected to increase the amount of debt that comes to the sale market, he added.
Despite the billion-dollar deals, there is more buyer interest for deals priced between $20 million and $60 million among all-cash buyers, noted Jack Howard, executive vice president and co-head of the loan sale advisory practice at CBRE Capital Markets.
Private capital, ultra-high net worth and family offices have been actively pursuing one-off non-performing loan opportunities at that price point. Many of these groups that have patient, long-term capital and aren’t dealing with legacy office exposure now see this as a once-in-a-generation buying opportunity, Howard said.
Most distressed loan sales coming to the market are backed by office assets across almost all major geographic markets. “Office debt is approximately 75% to 80% of what we’re being asked to evaluate and potentially market, though we’ve seen a notable increase in multifamily loans with performance issues over the last several quarters,” Howard said.
The entire commercial real estate industry is trying to get better insight into what the volume of distressed loan sales will look like. Although it’s a tough number to pinpoint, there are clues emerging in Trepp’s special servicing and delinquency rates on the CMBS sector. The overall delinquency rate on CMBS rose to 4.25% in August, up from 2.98% a year ago. Although office delinquencies have been accelerating, retail still remains the highest at 6.86%, followed by lodging at 5.85% and office at 4.96%. Through July, the overall CMBS special servicing rate through July was at 6.62% with retail reporting the highest levels at 10.26%, according to Trepp.
Loan Sales Are Accelerating
Historically, August has been a slower month for activity. However, loan sale advisory teams have been extremely busy advising lenders and underwriting potential loan sale opportunities.
“The feedback that we’re getting from many of our lender clients is that they’ve continued to take writedowns on troubled loans over the last several quarters and they’re getting closer to being in a position to trade at market levels,” Howard said. “I think you’re going to start to see volume pick up significantly in the fourth quarter that will accelerate and continue into next year.”
One deal to watch in September will be the FDIC sale of Signature Bank’s commercial real estate loan portfolio, which is expected to launch after Labor Day. The Signature portfolio includes a mix of assets and performance levels. JLL also expects a few other larger bank portfolios to hit the market before the end of the year. “The bank portfolios that we think are ripe to come to the market fall into the category of performing but non-core,” Ryan said. “For non-performing loans, we expect more to come to market as maturities come and go without the loan being paid off or modified, but the expectation is these are more likely one-off trades.”
In some cases, lenders are selling non-performing loans, and in other cases they are trying to get out in front of loans that are performing today but have the potential to default at maturity. Banks generally are not set up to own real estate. They especially don’t want to own office, which tends to be a capital-intensive property type due to tenant improvements, capital improvements and leasing expenses. So, they are looking to get those potentially troublesome loans off the books and sell them to someone who can deal with those issues if or when they do arise.
“You hear a lot of talk about kicking the can, but that only works if both sides are willing to participate,” Howard said. If a lender is willing to extend an existing loan to a borrower because they don’t want to take a loss or sell the loan at a discount, that typically only works if the borrower is in agreement and willing to recommit new capital to the deal. Many of the loan sales that are closing in this market involve situations where the value of the collateral is less than the loan amount; the borrowers are not willing to commit additional capital to the asset; and the lender is not interested in taking back the real estate, he added.