Lenders can no longer 'kick the can down the street' and so large volumes of loans maturing in 2015-17 will have to be dealt with. Christopher O'Dea reports.
Over the past 12 months, opportunistic real estate investors from North America have turned their attention to Europe. There is a general consensus that, right now, the region offers the best opportunities to invest in distressed situations, partly because such opportunities in the US have started to dwindle as the market mounts a full recovery.
But in a recent note to investors, entitled 'Is It 2007 All Over Again?', PCCP has suggested the US markets could be hit by another wave of distress.
William Lindsay, founding partner of Los Angeles-based PCCP, says the large volume of debt scheduled to mature between 2015 and 2017 will create new opportunities for investors in distressed property. Unlike 2007, "we don’t think the holders are going to kick the can down the road", he says. "There’s a giant pig in the python, and it’s going to be digested this time."
Trained as a lawyer, Lindsay is well acquainted with distress situations; he clerked for Chief Justice William Rehnquist on the US Supreme Court, which must allocate its limited time to the cases that are most difficult to resolve.
Today’s real estate investors face similar issues, he says. "There are more problems than there is capital to solve them."
In its 2014 outlook, PCCP notes the good news: CMBS delinquencies are at their lowest since February 2010, and more than 60% of the $406bn (€299bn) of commercial mortgages distressed in this cycle had been resolved by the third quarter of 2013.
At the same time, the economy is recovering, job growth in some areas is boosting suburban office markets, and both apartments and CBD office assets are thriving. Add in a global rotation of institutional allocations towards real estate and other alternatives, and it is understandable that "core open-ended [real estate] funds have long queues," says Lindsay.
But challenges remain. "The largest wave of maturities is now upon us," PCCP says, with approximately $1.7trn in loans coming due in the next three years. That is about 60% of the $3.5trn in commercial property loans outstanding, says Lindsay, and about half of those cannot be refinanced without more capital.
Banks are estimated to hold half of the real estate debt maturing and are unlikely to extend more credit. And with CMBS rates already topping 5%, PCCP predicts some borrowers will seek alternative debt sources to refinance – and recapitalise – before rising interest rates constrict funding. That is presenting distressed investors with a major opportunity.
"There’s going to be a big supply of busted deals on the market," Lindsay says. Astute investors in those situations can "get paid in terms of more attractive price or more attractive structure”, he says, with the potential to earn high absolute and risk-adjusted returns.
PCCP recently invested in Atlanta and Phoenix, and Lindsay says the company "likes markets where we’re a little ahead of the capital curve". He adds: "Both were hurt during the recession, but job growth has been strong, and capital hasn't come swarming back yet."
Macroeconomic themes in the US highlight where distressed opportunities might arise in areas with solid fundamentals. "Markets driven by energy or technology are strong, and likely to stay strong," he says.
Denver, for example, is a major beneficiary of North Dakota’s shale energy boom. In technology, he adds, "you’re going to see Seattle remain popular with capital, and have strong fundamentals”. The reason: "Amazon’s taking over the world."