Text on screen: PIMCO

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Text on screen: Megan Walters, Global Head of Research at PIMCO Prime Real Estate

Megan Walters: The foundations of the global commercial real estate market are shifting. A confluence of factors, including the sharpest rise in interest rates for more than 40 years, recessive economies and geopolitical uncertainty

Images on screen: Commercial office building exterior and interiors

we believe will see the largest downturn in commercial real estate since the global financial crisis 15 years ago.

For investors, this may seem daunting and the outlook challenging, which is why we focused on the topic during our May 2023 Global Real Estate Forum.

Images on screen: PIMCO forum room

We discussed real estate across all four quadrants. We identified the opportunities and the risks that will arise across public and private markets in both, debt and equity. Commercial real estate is far from monolithic sectors, such as multifamily, housing offices and retail have reacted in materially different ways. A combination of land use restrictions and high construction costs will reduce supply more than in any previous cycle, underpinning real estate values over the long term.

Navigating this landscape demands a differentiated approach. Secular trends, including demographics, digitization and decarbonization, will play out differently across regions, underscoring the need for granular understanding of local market dynamics.

Text on screen: We see near-term potential in real estate debt,

Images on screen: Exterior office buildings

Real estate debt has been in the spotlight. In our view, we see unprecedented potential in debt in the near term. We anticipate that reduced liquidity pressure on fundamentals and geopolitical tensions will cause short to medium term distress. This is why we believe lending has emerged as the most attractive avenue of investment from relative value perspective.

Investors can benefit from high quality assets with lower loan-to-value ratios and attractive spreads. Commercial mortgage-backed securities, whilst negatively perceived by some, may in fact offer high yields at significant discounts. We see potential in commercial real estate lending, loan portfolio sales, non-performing loans and rescue capital.

This includes newly originated debt hitting the market as many lenders retreat to the sidelines.                    

Text on screen: Looming $1.5 trillion wall of loan maturities through 2025

Images on screen: Exterior office buildings

Distressed public and private debt will be part of a wave of real estate loans maturing through 2025, including at least 1.5 trillion US dollars worth in the US alone. Private credit and special situations will gain prominence and distressed banking sectors represent opportunities to seize market share from non-bank lenders.

When we think about individual sectors and where the opportunities are for long-term growth and value for investors, we've looked at each of the regions and discussed traditional sectors like office and emerging sectors such as data centers and how these are impacted by trends.

These include longer-term secular trends such as society and demographics, decarbonization and sustainability, and digital, plus the shorter cyclical issues like political change and financial market dislocation.

We anticipate multifamily housing as an investment class will reap the benefits of longer-term trends, such as urbanization, the growing rate of household formation and rising home ownership costs.

Text on screen: Multifamily, Debt: Development and value add projects

Images on screen: Apartment buildings and townhouses

With banks sidelined, we see attractive debt investment lending opportunities for development and value add projects and on the

Text on screen: Multifamily, Equity: Newer properties in select urban gateway markets

Images on screen: Apartment buildings and townhouse

equity side, we see potential in newer properties in select urban gateway markets at less expensive entry points.

Text on screen: Logistics, Industrial storage and distribution facilities

Images on screen: Storage and distribution facilities

In the logistics market, we've seen e-commerce grow and this will continue to drive demand for industrial storage and distribution assets over the secular horizon.

Capital values for logistics facilities have declined across mature markets, especially in the U.S. and northern Europe, but we expect the sector to benefit as investment flows shift from office and retail to logistics supported by low vacancy rates and rent growth.

Growth in demand for datacenter capacity is among the most powerful and visible secular trends in the global economy. Demand has mushroomed with continued digitization of economies.

Digital sovereignty regulations in Europe are driving demand for localized capacity. We see growing appetite from infrastructure investors.

FULL PAGE GRAPHIC: TITLE –European data centre focus markets. The graphic shows a map of Tier 2, and Tier 3 Data Centre Markets:  Tier 2, shown in dark blue dots, includes Berlin, Madrid, Milan, Stockholm, Zurich, Copenhagen, Oslo, and Warsaw; and Tier 3, shown in light blue dots, includes Athens, Sofia, Budapest, Bucharest, Helsinki, Barcelona, Lisbon, Zagreb, Prague, and Rome.

We recommend a focus on tier two and tier three markets in Europe. And we also see good tactical investment opportunities in public equity markets in the US, where REITs lost about a quarter of their value in 2022, creating pricing discrepancies.

Whether we live in the US, Europe or Asia Pacific, the past few years have seen us all experience unprecedented challenges which have influenced how buildings are used.       

FULL PAGE GRAPHIC TITLE – Seeking relative value across four quadrants of global commercial real estate investing. The graphic shows the global real estate debt and equity markets, both public and private where PIMCO seeks relative value opportunities. The upper left quadrant shows Public debt, where PIMCO capitalizes on historically wide spreads and impaired liquidity. The lower left quadrant shows Private debt, where PIMCO takes advantage of motivated sales of discounted debt and rescue financing opportunities. The upper right quadrant shows Public equity (Real Estate Investment Trusts, or REITs) where PIMCO exploits pricing discrepancies via tactical investments. The lower right quadrant shows Private equity, where PIMCO focuses on sectors with secular tailwinds, including logistics, residential, alternatives, and select office and retail properties.

But real estate is a broad sector where investors may benefit from looking at both secular and cyclical trends across public private markets, for both debt and equity.

We see the greatest opportunities in the multifamily residential logistics and data center sectors and believe that global platforms are best positioned to make tactical trades and exploit pricing discrepancies between public and private markets.

Images on screen: PIMCO trade floor

In essence, we believe investors should take a broad approach to debt, but go narrow and deep on equity.

Their focus should be on high conviction tactical deployment into stressed and deeply discounted assets that are facing immediate liquidity pressures.

Text on screen: For more insights and information, visit pimco.com

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Disclosure

About PIMCO Prime Real Estate

A leading global real estate investor and manager, PIMCO Prime Real Estate (formerly Allianz Real Estate) is a PIMCO company and part of the PIMCO real estate platform, focusing on the Core and Core+ segments of the market and managing the Allianz group’s $97B+ real estate mandate. PIMCO’s real estate platform is one of the largest and most diversified in the world, with over $190B(1) in assets and a broad set of solutions that leverage decades of

expertise across public and private equity and debt markets.

Note:

As of December 2022. All figures in USD. (1)AUM includes $101.5B in estimated gross assets managed by PIMCO Prime Real Estate, which includes PIMCO Prime Real Estate GmbH, PIMCO Prime Real Estate LLC, and their subsidiaries and affiliates. PIMCO Prime Real Estate LLC investment professionals provide investment management and other services as dual personnel through Pacific Investment Management Company LLC. PIMCO Prime Real Estate GmbH operates separately from PIMCO.

All investments contain risk and may lose value. Investments in residential/commercial mortgage loans and commercial real estate debt are subject to risks that include prepayment, delinquency, foreclosure, risks of loss, servicing risks and adverse regulatory developments, which risks may be heightened in the case of non-performing loans. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Investments in mortgage and asset-backed securities are highly complex instruments that may be sensitive to changes in interest rates and subject to early repayment risk. Private credit involves an investment in non-publically traded securities which may be subject to illiquidity risk.  Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.

Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.

This material contains the current opinions of the manager and such opinions are subject to change without notice.  This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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