/perspectives/sector-views/commercial-real-estate-cash-is-king

Commercial Real Estate: Cash Is King

With property values under stress, prepared real estate investors can find opportunity.

May 16, 2023


This Commercial Real Estate sector report is excerpted from the Second Quarter 2023 Fixed-Income Sector Views.

Increases in interest rates have caused the pace of commercial real estate sales to fall sharply because it has led to higher cost of capital, tighter credit standards from lenders, and increases in operating costs. For borrowers of floating rate mortgages, the cost to hedge against the risk of further interest rate increases can be prohibitive. But certain credit metrics, like loan-to-value ratios on newly originated commercial loans, are now near the conservative levels last seen during the Global Financial Crisis.

Investors who do not have to sell real estate or refinance mortgage loans are generally on the sidelines. But market stress often leads to opportunity, as some investors may be forced to sell or refinance in the current environment. This means investors with dry powder may be able to acquire properties at lower prices, and lenders will see opportunities to improve their position when borrowers seek short-term extensions with hopes of a bridge to a better rate environment. Investors and lenders have used these requests to require borrowers to pay down loans, increase coupons to market rates, establish new covenants or cash sweep protections, and provide credit enhancement for operating and capital shortfalls. Because we see the current environment as driven primarily by the rising cost of capital and not by a fundamental supply/demand disconnect in commercial real estate, we expect these opportunities will wane as interest rates begin to moderate.

In both real estate debt and equity investments, we are focused on defensive strategies in the current market. We look for properties with strong cash flows backed by sponsors that have the liquidity needed to cover potential operating shortfalls and capital needs. These sponsors typically have the ability to be patient and defer a sale or refinance until a more favorable market returns. Our focus continues to be on sectors with strong demand drivers: multifamily, logistics/warehouse, neighborhood retail, and hospitality in undersupplied markets. We continue to be cautious on office investment, where tenant demands for rent concessions and costly improvements are high.

Mortgage Lending Standards Have Tightened to GFC Levels

Certain credit metrics, like loan-to-value ratios on newly originated commercial loans, are now near the conservative levels last seen during the Global Financial Crisis.

Very Little Industry Dispersion in the Investment-Grade Index

Source: Real Capital Analytics. Data as of 1.31.2023. Note: chart represents newly originated commercial property loan LTV ratios.

—By Jennifer A. Marler and Farris Hughes

 
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This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-backed securities may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.

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Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors.

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