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The resetting of interest rates on trillions of dollars of floating rate and maturing real estate debt is creating significant distress on real estate investments. For over a year, lenders have been kicking the can down the road by extending maturities and ignoring loans where cash flow is barely covering debt service. This is becoming an issue for banks and borrowers as interest rates have stayed higher for longer.
To quantify the debt resetting problem, nearly $2 trillion of the $4.7 trillion in commercial real estate loans nationwide will mature during the next three years, according to the Mortgage Bankers Association. Whether real estate loans were financed with floating rate debt or are maturing, the next interest rate reset will be higher than the previous rate and the cash flow from real estate properties may not be sufficient to cover the debt service. The solution for existing real estate owners to avoid foreclosure is to bolster their capital by taking on high rate mezzanine or preferred. These financings are a bitter pill for real estate owners and highly attractive lower risk structured investments from the new investors’ point of view.
There are billions of dollars of private debt and private credit deals happening every day. Interest rates are predicted to slowly come down over the next 1-2 years and this will provide an attractive investment opportunity for investors.
It is important to assess what the smart money is doing. Stephen Schwartzman of Blackstone, which manages over $1 trillion, said:
“The last two years the campaign by the central bank has resulted in muted returns. We’ll look back at 2024 as a cyclical bottom for our firm. We are heading to a better environment with the inflation and cost of capital environment moderating. We can see the pillars of a real estate recovery coming into place. We are not waiting for the all clear sign and believe the best investments are made in periods of uncertainty. Real estate prices are bottoming and there’s a great opportunity to move fast and buy assets at beaten-down prices.”
Blackstone followed up their statement in April 2024 with a $10 billion acquisition of a multifamily REIT.
According to a recent article from CNBC, high-net-worth individuals are still focusing heavily on real estate investments. Real estate investments typically represent 27% of these individuals’ portfolios, according to Michael Sonnenfeldt, founder and chairman of Tiger 21, a network of ultra-high-net-worth entrepreneurs and investors.
Now is the time to get back into investing in real estate. And it is for the same reasons that real estate has always been attractive:
The incredible rise in interest rates by the Federal Reserve has caused financial distress for real estate investments. But we are near the inflection point where structured real estate investment opportunities are attracting significant capital.
Real estate investment funds are utilizing structured capital investments to achieve exceptional returns with attractive risk mitigation from financially distressed real estate. The next several years will provide investment rewards for those investment funds with capital-in-hand that have the requisite distressed investing experience, opportunistic deal structuring capability and deal sourcing relationships. Setting aside the real estate investment strategy niches such as self-storage, industrial, and medical office, the most attractive real estate investments today have a structured capital solution that includes: private credit, rescue capital, preferred equity and GP Co-Investing. Here is a brief discussion:
There are hundreds of billions of dollars of financially distressed assets. Funds with opportunistic capital that can be deployed quickly can complete acquisitions at attractive valuations (high cap rates). In addition, experienced investors can support or rescue financially undercapitalized properties with preferred equity. Sponsors may be forced by lenders to accept a capital infusion from new investors which will provide the new investors with an enhanced upside.
Funds that can provide restructured debt and mezzanine financing may be able to achieve a high teens return with preferential repayment terms and equity upside. Coming in now as interest rates and cap rates have peaked will provide solid returns with downside protection.
Small and mid-sized regional banks, agency lenders and private lenders have specific criteria such as loan loss reserves, non-performing loan ratios and other banking portfolio requirements to determine how much and what kind of debt to unload. As lenders deliver, buyers of NPLs are starting to see attractive investment terms and structures.
Investment managers are highly motivated to raise additional equity to protect their investments and are allowing new equity to come in at the GP level. From an investor’s point of view, GP co-investments are an attractive way to deploy investment capital. A GP co-investment (sometimes called Co-GP investment) differentiates itself from other investments in one very important way: instead of investing on the LP side, you invest on the GP side. Investing a relatively small amount alongside the operating GP at an opportunistic valuation allows the GP co-investor to share in the LPs’ profits and fees. So, not only do you earn your normal LP profits, but you can also share in the fees and profits produced by the larger amount invested by LP investors. While LPs may only receive 1.5x to 2x return, the relatively smaller GP investment amount will be enhanced significantly by participating in the LPs profits, thereby producing a possible 2.5x equity multiple return.
If you are seeking investment opportunities in real estate resulting from the distress caused by high interest rates, consider investing with a real estate private equity fund focused on these opportunistic real estate investments. The CityVest.com marketplace has an investment opportunity that you may want to consider:
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