Distressed Commercial Real Estate Offers Actionable Opportunity
Text on screen: PIMCO
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Text on screen: How has the recent banking crisis affected commercial real estate markets?
Seray: Commercial real estate markets were already in stress coming into 2023 given the precipitous rise in interest rates, slowing fundamentals, declining transaction volumes, and limited liquidity.
Text on screen: Seray Incoglu, Portfolio Manager, Commercial Real Estate
The closure of Silicon Valley Bank and Signature Bank created aftershocks that we expect to heighten distress, likely including a significant tightening of credit standards
Text on screen: Smaller banks represent nearly 70% of bank commercial real estate lending
Images on screen: Commercial building exteriors, interior office space
While smaller banks hold 34% of total assets within the banking sector, they represent nearly 70% of bank CRE lending.
A pullback by regional and community banks will materially reduce credit availability for commercial real estate with really no obvious lower cost replacement lender in sight.
This can present attractive opportunities for sophisticated investors who can skilfully navigate private and public markets.
Text on screen: Why do we expect these markets to be so severely impacted?
Text on screen: TITLE – Current pressures in the CRE markets: BULLETS – Existing CRE exposure on bank balance sheets, Low issuance in the public markets, Large amount of debt maturities
There are multiple factors putting pressure on the commercial real estate space in the current environment, the key themes we are closely monitoring are the existing CRE exposure on bank balance sheets, low issuance in the public markets and the large amount of debt maturities looming over CRE.
Text on screen: CRE exposures have ballooned on bank balance sheets
Images on screen: Commercial building exteriors
First, CRE exposures have ballooned on bank balance sheets and are becoming an increasing focus for regulators, particularly as a result of this recent banking crisis
FULL PAGE GRAPHIC: TITLE – Increase in CRE loan exposure since 2018.The bar chart on the left shows a 29% increase for large U.S. banks; the chart on the right shows a 61% increase for U.S. regional and community banks.
The largest US banks have seen an increase of commercial real estate loan exposure of 29% since 2018, and regional and community banks have grown even faster at 61% over that time frame. The ratio of CRE loans to regulatory capital, which is a key variable for regulatory examiners, is at its 5 year peak for half of the largest 50 banks. This has all led to a material slowdown in commercial real estate lending.
Text on screen: We believe public CRE markets are currently not a stable source of liquidity
Images on screen: Commercial building exteriors
Secondly, further intensifying the impact, we believe public commercial real estate markets are currently not a stable source of liquidity for borrowers given market conditions. CMBS spreads remain wide and issuance is at historic lows. Total private label origination volume in first quarter of 2023 was down 85% compared to the same time last year. It appears that public markets still have a long road ahead before seeing normalized issuance levels.
Text on screen: Nearly $900B of loans set to mature through 2024
Images on screen: Interior office space
Lastly, looming as a storm cloud are the nearly $900B of loans set to mature through 2024. Given current market dynamics, a significant portion of borrowers will need to look for alternative sources of capital as their loans mature.
Text on screen: TITLE – Implications for borrowers without access to alternative capital: BULLETS – Growing loan defaults, A continuation in the movement of loans to special servicing, Sizable refinance shortfalls on existing debt maturing
For those that cannot, we expect to see growing loan defaults, a continuation in the movement of loans to special servicing, and sizable refinance shortfalls on existing debt maturing. We anticipate that this will lead to increased distressed financing and sales activity.
Text on screen: Where does PIMCO see
We believe this stress in the commercial real estate market will create actionable opportunity for nimble investors.
Text on screen: TITLE – Resulting investment opportunities: BULLETS – Need for non-bank lenders in the most senior parts of the debt stack, Non- and sub-performing loans, Rescue capital, Deep value equity investments, Loan portfolio sales
Specifically, we see an opportunity for non-bank lenders in the senior parts of the debt stack to fill the gap resulting from retrenchment of banks and the new issuance lull in public markets.
We also expect to see a materially improved opportunity set in non and sub-performing loans, rescue capital, and deep value equity investments.
We believe a number of loan portfolio sales will also likely come to market. These sales may require creative structured solutions, where PIMCO has significant experience.
Text on screen: For more insights and information, visit pimco.com
Text on screen: PIMCO
Commercial Real Estate (CRE); Commercial Mortgage-Backed Securities (CMBS).
Ratio of CRE loans to regulatory capital, SOURCE: S&P Capital IQ: CIQ Pro: Market Monitor as of December 31 2022
Total private label origination volume in first quarter of 2023, SOURCE: BofA Securities Research as of 3/31/23
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