Don't Follow PE Into the Real Estate Fray

Commercial real estate ('CRE') is on the verge of collapse...

Commercial mortgage-backed securities ("CMBS") – bonds that collect payments from CRE properties – are as unhealthy as they've been in the past decade. Thirty-day office CMBS delinquency rates skyrocketed from just 1.5% in December 2022 to 6.9% as of July.

That's the highest level in a decade... when delinquencies were still recovering from the peak of the Great Recession.

In the U.S. alone, CRE firms face a staggering $1 trillion in debt maturing this year. And if delinquency rates are any indicator, they don't stand a chance of paying off that debt.

We touched on the problems with CRE creditworthiness yesterday. Credit-ratings agencies like Fitch and Moody's are drastically downplaying the risk in these businesses.

But while much of the market will be caught unawares, one group is already preparing for what's coming.

Private-equity ('PE') firms are playing the long game...

Many have struggled to find deals in CRE over the past few years. Folks don't go into the office as much in the post-pandemic world, so office buildings are far less attractive investments.

And higher interest rates have made it more expensive – and more risky – for PE firms to invest in other CRE opportunities.

While they've been waiting around, PE has amassed about $400 billion in dry powder... or cash ready to be invested. And rather than rushing to find investments, these firms are now waiting for disaster to strike.  

According to market-data firm Preqin, about 64% of that $400 billion is set aside for property investment in North America. That's the highest share in two decades.

John Brady, global head of real estate at Oaktree Capital Management, summarized the situation well at a recent investment conference...

We could be on the precipice of one of the most significant real estate distressed investment cycles of the last 40 years.

Brady expects "exceptional bargains" to come out of this crisis.

Those 'exceptional bargains' might be tempting for everyday investors, too...

But that doesn't mean you should jump into a bunch of discount CRE stocks.

A lot of these companies will go bankrupt. PE firms are waiting to pick up the pieces after the fact. They have the capital and expertise to handle a shaky CRE market. You likely won't be able to take advantage of this opportunity the way they can.

For now, it's best to stay clear of CRE exposure. There could be a better chance for the individual investor sometime in the future... but this market could fall a lot before it starts rising.

Until PE firms are done cleaning up the mess, you're better off waiting on the sidelines.

Regards,

Rob Spivey
August 15, 2024