Capital Markets Industry Brief
It is with some level of irony that legendary real estate investor Sam Zell, who made a fortune buying distressed commercial properties, died last year in May at the age of 81. The man who nicknamed himself the “Grave Dancer” for his interest in troubled companies and property assets sold the company he created, Equity Office Properties Trust, to Blackstone in 2007 for $39 billion. It was the top of the market in that cycle, and if a young Zell were alive today, he might be dusting off his playbook for another go at CRE, in what future pundits would call, “the second coming of Sam Zell.”
As the first quarter of 2024 got underway, the word “distress” is on the lips of everyone in the Capital Markets space of commercial real estate. Everyone expects it. We have seen the early innings of the ballgame, with ‘extend and pretend’ deals among nearly every asset class and foremost, of course, in the office sector. Further, the funds are in full formation, getting in position to buy not only the physical assets of real estate, but the debt, too. And they are humming Billy Joel’s I’m in a New York State of Mind.
Recent announcements include:
- SL Green Realty launched a $1 billion opportunity debt vehicle targeting New York City
- RXR and Ares Management formed a $1 billion fund to buy distressed office assets in New York City
- Ethan Penner and Chad Carpenter teamed up to start a new REIT that is raising $1 billion to fund debt solutions for office investors and owners
- Goldman Sachs has a new $2.6 billion fund earmarked for commercial real estate lending
Brookfield Asset Management is rumored to be entering the bargain hunting, according to a story by Bloomberg, with CEO Bruce Flatt saying at a Goldman Sachs Group-hosted investor conference: “The easiest way to make money in real assets, especially in real estate, is to buy great assets with bad capital structures.” He added that “there isn’t going to be just one event, but rather, they’re just going to be coming in the next 24 to 36 months, and hopefully we can capture some of those.”
Blackstone President John Gray, at the same Goldman Sachs event, disclosed that his company had already completed $7 billion in a half dozen distress deals with banks.
That there is opportunity in the distressed space is abundantly clear: MSCI estimated the existence of $85.8 billion in existing property-level distress. If the word ‘existing’ is in a sentence like that, it means there is more to come.
While the current downturn in property transactions is substantially down, and valuations are plummeting, too, the U.S. and other major economies have not been in a recession, and yet here we are, taking about distress with the gravity it deserves. And with savvy operators like Bruce Flatt forecasting several years to work through this cycle, it’s worth a reminder of what happened after the Great Financial Crisis.
First, there was a recession and it lasted 18 months, one of the longest in post-WWII history, and it was officially over by June 2009. However, the effects on the overall economy were felt for much longer. The unemployment rate did not return to pre-recession levels until 2014, and it took until 2016 for median household incomes to recover. We know from studying market reports and data on commercial real estate, and this varies by market and cities, but it was also around 2014-2015 that we started seeing real rental-rate appreciation across all property types, with declining vacancy rates and net absorption emerging from negative to positive numbers.
The numbers are in for 2023, and it wasn’t pretty.
Transaction volume of commercial real estate sales declined 41% during 2023, compared with 2022, according to MSCI, a New York City-based global provider of equity, fixed income, real estate indices and multi-asset portfolio analysis tools.
For major metros, the slide was 37%; non-major metros were down 42%. That represented 1,569 properties for the former and 4,697 for the latter. By property type, the biggest decline was for multifamily, at 50%. Industrials were down 43%; hotels, 42%; office off by 32%; retail by 31%; and development sites by 27%. Seniors’ housing and care bucked the trend with a 9% increase. The sector had been hit hard during the pandemic and went down while other property types raced upward. That has since reversed.
Anecdotally, offices in the over-supplied central business district hubs such as San Francisco have fallen in value by 40% since March 2022.
According to the RCA CPPI National All-Property Index, which tracks the value of property deals that closed, U.S. commercial real estate prices are down 11% from peaks seen around the time the Federal Reserve began raising interest rates in early 2022. Many expect that number to be negative again in 2024.
