February 7, 2024
US CRE debt markets continue to navigate “new territory”
Altus Group’s CRE Exchange recently welcomed special guest Dr. Stephen Buschbom to discuss the dynamic US CRE debt market.

Omar Eltorai | Altus Group

Keeping a finger on the pulse of CRE capital markets

Altus Group’s CRE Exchange recently welcomed special guest Dr. Stephen Buschbom to discuss the dynamic US CRE debt market. As research director at Trepp, a leading data and analytics firm, Buschbom has his finger on the pulse of CRE capital markets data and the financial modeling that investors are using to inform decisions.

Higher interest rates and tighter liquidity are creating significant challenges for new transactions and loan maturities, and some elements present in today’s CRE and CRE debt markets are reminiscent of past cycles. According to Buschbom, the 1980s also saw a rapid adjustment in interest rates, while loans that are moving quickly from performing to problem loans is a phenomena not unlike what occurred during the Great Financial Crisis (GFC). “That similarity to the 1980s and 2006-07 periods are showing through. But we’re in completely new territory with where we’re at now because of informational transparency, technological advancements, the generational shifts and demographics that are going to make things very interesting in the housing market 15 years from now,” he says.

Buschbom sat down with Altus’ Senior Market Analyst Cole Perry and US Director of Research Omar Eltorai to discuss the rate environment, liquidity, key risks ahead, and the outlook for US CRE debt in 2024 and beyond.

Perry: Can you give us a recap of 2023 CRE debt?

Buschbom: We came in with very low delinquency rates and we already knew with rates going higher that origination volume would be relatively muted compared to 2022. What we didn’t foresee was the 50% plus drop that has actually taken place. Myself, Manus Clancy (Trepp Senior Managing Director), and Lonnie Hendry (Trepp Chief Product Officer) all put in some guesstimates of what the 10-year treasury would be at the end of 2023, and it’s laughable. I was thinking 3, 3.25 or maybe as high as 3.5%. Manus was saying it would dip below 3. None of us were in the ballpark. What we saw happening is definitely not what’s taken place.

Eltorai: I think all estimates were wrong coming into 2023, and we will see how much longer that “higher for longer” lasts. How would you frame up the year ahead in the CRE debt space?

Buschbom: One of the big issues that we’ve had in CRE is low transaction volume. One of the reasons keeping transaction volume low is high cost of capital. There’s also that catch-22 issue of low transaction volume means lack of transparency, which means additional low transaction volume.

The deals that are getting done are the best of the best. Any repeat sales indices that we’re going to be taking signals from are going to be the upper bounds, call it the more positive estimate of value trends. Then there are the more pessimistic ends where we’re going to get reevaluations from problem loans. Think about how wide that gap is.

If we start to see that narrow this coming year, that’s going to be a really good thing. Because the wider that spread is between positively biased repeat sales indices and the depressed valuations that we get in the problem loan market, that width and that bid-ask (gap) is indicative of the problems at large. To the extent we start seeing that convergence take place, that’ll be a sign that we’re close to the trough and maybe closer to an inflection point.

We’re nowhere close to that at this point. We probably won’t start seeing convergence until we do finally get some Fed cuts and we start seeing players move off of the sidelines. Once cost of capital starts coming back in and we do start seeing more deal churn, that’s where I’ll feel a lot better so long as inflation has been tamped down sufficiently that we have a recovery path in sight.

Eltorai: Do you think cuts have to proceed that narrowing?

Buschbom: To some degree, yes. If I’m going to be doing transactions in any way, shape or form in today’s market, I’m going to be very attracted to the super heavily discounted close to land value core assets, and core locations. I’m going to be buying for such a low basis that I’m okay with it being a 20-year play – the sort of 1980s land plays that built generational wealth.

The fact that you’re seeing some of those take place, whether or not you agree with the price, they’re buying out of the strategy they’re taking. The fact that you are seeing heavily discounted office transactions in San Francisco at least tells me that – if somebody is willing to start catching what we’re all calling a falling knife, whether or not you think they’re going to get cut, still speaks to where we’re at in the real estate cycle.

Eltorai: In terms of narrowing that gap, what piece do you think will likely move first, or even move more over the coming years? Is that going to be coming from the existing debt space, or do you think that the transaction activity in those repeat sales is actually going to narrow more?

Buschbom: I hate to pin it to any one sector. I think it will be a combination. With the amount of private capital that’s been built up, you will start to see mounting pressure to use those funds. The pressure to deploy is real, and we probably will start seeing that maybe be a leader. I don’t know for sure, but that’s where I would guess you might see some of the larger volume taking place.

In many ways, the lack of distressed note sales or discounted payoffs is a good thing to me. We saw so much of that in 2009, 2010 and 2011 that spoke to just how damaged liquidity was back then. Today, we have a liquidity factor that we use in some of our models that’s on a scale of 1 to 10, 10 being the best and 1 being the worst. In the late 1980s, early 1990s and in 2008-2009, that index reached 1 or 0. Effectively, there was no liquidity. Right now we’re sitting at about a 3.5 or 4. So, it’s definitely not great, but it’s not as bad as it could be.

Perry: Altus Group did a sentiment and expectations survey that asked folks to tell us their expectations for capital availability within the next 12 months. The concern is both cost and availability and about 3 out of 5 told us that bank capital will not be available, or not very available, and nearly the same fraction said the same for securitization. Are you seeing the same things? And what other trends are you seeing across CRE collateral?

Buschbom: We are seeing some of that similar sentiment. When I think of all that we could lay out for the coming year on what we would be concerned about, the banking regulation causing further retrenchment is a real risk. I think that’s being well-communicated to the parties and it’s being taken into account.

My hope is that there will be some relief or walking back of the regulatory requirements, because a 20 or 30% increase in risk capital is just a gut punch at a time when we could least afford it in the market. I’d like to think that regulators will realize there’s a real liquidity constraint in place already, and if we put this in place too quick or too aggressively in terms of what’s going to be required, that will probably prolong some of the pain by one to three years.

Perry: So regulatory is certainly one of them, but do you see any other big areas of risks or concern that you’re watching out for?

Buschbom: I’m glad you asked. We were kicking around some macro factors earlier today. The big one that really stands out that would keep me awake at night is the geopolitical landscape. That’s a real one that would come out of left field that could be extremely painful. Just the fact that you’re seeing tensions, these little fires being lit all over the globe in different ways, is concerning.

Eltorai: Geopolitical risk is a tough one to model too.

Buschbom: Yes, always. To your point, anything that you can’t model, that’s the systematic risk that we’re just going to have to accept. At this point, I think it gets back to what is getting done is what you have confidence over. There are a lot of things outside of your control. So, staying true to your investing thesis – core locations, core markets or whatever your specialty is, is especially important right now.

Eltorai: Insurance costs became a concern for many lenders in 2023. What do you think some of the main priorities will be for lenders through 2024?

Buschbom: I’m glad you mentioned the insurance repricing or question of coverage period since you’ve seen some policies not get renewed. That’s one issue that is still probably not priced in enough. It’s gone up over 100% in some markets. So, I think some of that property efficiency probably will continue to be a very interesting theme.

As an industry, we’ve never really taken to ESG or some of the other topics du jour. But I think what always resonates is efficiency and long-term viability of your asset. Over the coming couple of years, I think we’ll start seeing some really interesting innovation in data metrics and how we build out some of the older assets in the future. There’s a lot of strategies that you can take to increase your physical resiliency or efficiency. So I’m optimistic that we’ll continue to see technological advancements that will surprise a lot of us.

Perry: How do you expect the CRE debt market to perform in 2024?

Buschbom: In terms of high-level distress, we’ll continue to see it grind higher. We haven’t had enough issuance to correct for the denominator issue. For a little inside baseball on our delinquency rate calculations, it takes about five to six months for a deal to season before it’s eligible for inclusion in our delinquency rate calculation because a loan that was just originated last month isn’t going to go delinquent next month.

Fourth quarter was a heavy roll quarter for office coming due. Fortunately, some of these are single-asset single-borrower deals that executed extension options. So, it pushed it out into the fourth quarter of 2024. But there still is about $38 to 40 billion left in total in December across all CMBS, and a lot of that is office. That might be the highest dollar amount by property type that’s coming due. Maybe the office delinquency rate hits 7%, and I think if you’re talking about urban office, non-defeased, that still is a reality.

We continue to see a lot of modifications and creative capital structuring to fill the valuation gap and justify these modifications. My hope is that maybe over the second half of the year we do start seeing a drop in rates. Once we start seeing modified loans exit the universe because they’re able to obtain debt elsewhere, that’s my go-sign for trying to pinpoint the trough or the inflection point.

Perry: What do you see as the biggest industry changes in 2025 and beyond? And what are those driving forces? Are they regulatory or are there credit issues?

Buschbom: One of the big ones is always going to continue to be regulatory. We have seen some pullback in Europe, in terms of the stringency of plowing forward to try and hit sustainability goals. It’s not like they’re going away wholesale. That you’re continuing to see urban cities adopt these for, at the very least energy efficiency, that’s just a natural precursor to try to incentivize building owners to invest for the long term. The C-PACE program is one area that has absolutely shattered any sort of expectations. So, from an innovation standpoint, sustainability standpoint, that’s a place that will continue to be very interesting.

Perry: How do you see capital stacks changing in the next 3 to 5 years? And are there other or different sources of capital that might pop up in that time period?

Buschbom: I think international flows could be very interesting. There’s been plenty of changes and cross-border capital flows this year. I’m interested to see exactly how much preferred equity or new debt we see enter structures. Predominantly, we’ll probably see it in the form of equity. You’re not going to leverage a deal any more than it already is in the current environment of deleveraging. So, we will see exactly how much existing owners are willing to stomach to try and salvage a deal.

Perry: What do you think about CRE and AI? What do you anticipate the future being as we take in this new technology? How is that going to impact your work in debt research?

Buschbom: Commercial real estate is very heterogeneous in general, but especially with respect to the contracts and a lot of the data that’s managed. Think about how much opportunity there is to mine contract data, or document images in general, and what that could mean for standardization or efficiencies, and in particular speed of execution going forward. That’s something that we continue to monitor very closely.

Visit our CRE Exchange podcast page to listen to the entire conversation on the US CRE debt market with Trepp’s Stephen Buschbom. Tune in now.


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