Macro

US Commercial Property Crash Deepens, $1 Trillion Debt Maturing

Private equity targets $256 billion in distressed U.S. real estate as $1 trillion debt matures this year.

By Jack Wilson

7/10, 07:00 EDT
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Key Takeaway

  • Private equity firms are targeting North America with 64% of $400 billion in dry powder for distressed US commercial real estate.
  • Almost $1 trillion of US commercial real estate debt maturing this year could lead to rising defaults and more distressed asset sales.
  • Smaller lenders, particularly regional banks, face significant risks from falling CRE values, potentially exceeding 2008 financial crisis levels.

Distressed Real Estate Opportunities

Distressed investors are eyeing what they consider one of the best opportunities in a generation to acquire troubled U.S. real estate assets. The commercial property market continues to face significant challenges, creating a fertile ground for private equity (PE) firms. According to Preqin data, about 64% of the $400 billion in dry powder set aside for property investment by the industry is targeted at North America, the highest share in two decades. This strong U.S. focus could mean other regions may not attract the same level of demand, potentially delaying the resolution of troubled loans and properties elsewhere.

The U.S. commercial real estate market has been hit hard, with office values falling by nearly a quarter last year, more than in Europe, due to the pandemic-induced shift to remote work. Almost $1 trillion of debt linked to commercial real estate is set to mature this year in the U.S., according to the Mortgage Bankers Association. Rising defaults as borrowers fail to repay will create more opportunities for buyers of distressed assets. Rebel Cole, a finance professor at Florida Atlantic University and advisor to Oaktree Capital Management, likened the current situation to the early stages of the Savings & Loans crisis and the 2008 financial crisis, stating, “There’s a tsunami coming and the waters are pulling out from the beach.”

Private Equity Firms Poised to Capitalize

Private equity firms are positioning themselves to take advantage of the deep discounts in the U.S. market. John Brady, global head of real estate at Oaktree, emphasized the potential, stating, “We could be on the precipice of one of the most significant real estate distressed investment cycles of the last 40 years.” The focus on the U.S. market means other regions could be left with lower-quality bidders, potentially dragging down values in Europe and Asia or leaving some markets in a state of stasis.

The opportunity in the U.S. is driven by lenders pulling back from commercial real estate due to rising borrowing costs and plunging values. PGIM estimates a gap of almost $150 billion between the volume of loans coming due and new credit availability this year. John Graham, CEO of Canada Pension Plan Investment Board, highlighted the attractiveness of the U.S. market, stating, “The big market is where people find the opportunities.”

Smaller lenders are particularly vulnerable due to their real estate exposure. New York Community Bancorp, for example, had to take a capital injection of more than $1 billion earlier this year. Pimco warns that more regional bank failures are likely due to property debt. Oaktree’s analysis suggests that if commercial real estate values fall by only 20% from their peak, the number of U.S. banks at risk would exceed levels seen during the 2008 financial crisis.

Challenges in the Global Real Estate Market

While the U.S. market looks attractive to private equity buyers, the overall pool of PE capital for commercial real estate has shrunk. Preqin data shows that the amount of money set aside for real estate debt strategies globally by firms shrank by 26% to $56.1 billion through May from the end of 2021. This could limit buyer interest in non-performing commercial real estate loans from regions like Korea to China.

One key deterrent for investors in Europe is the robustness of valuations of real estate and loans. The European Insurance and Occupational Pensions Authority noted that valuations “may not always provide an accurate reflection of the true worth of the assets, especially in the light of changing market conditions.” In Germany, for example, banks update valuations of buildings they have financed less regularly than their U.S. counterparts, meaning it takes longer for problems to surface. The European Banking Authority Chair, Jose Manuel Campa, warned of a further increase in non-performing loans, stating, “This is a trend that’s not going to be short term.”

Street Views

  • Rebel Cole, Florida Atlantic University and advisor to Oaktree Capital Management (Bearish on US commercial real estate):

    "Compared with the Savings & Loans crisis and 2008, we’re still in the first or second innings when it comes to troubled assets. There’s a tsunami coming and the waters are pulling out from the beach."

  • John Brady, Oaktree (Bearish on US commercial real estate):

    "We could be on the precipice of one of the most significant real estate distressed investment cycles of the last 40 years. Few asset classes are as unloved as commercial real estate and thus we believe there are few better places to find exceptional bargains."

  • Omar Eltorai, Altus Group (Neutral on global market recovery outside North America):

    "The strong North American economy, deeper markets and currency strength may contribute to a delayed market recovery outside the region."

  • John Graham, Canada Pension Plan Investment Board (Bullish on US opportunities for private equity):

    "When you start to get into the cycle, the big market is where people find the opportunities... The US is the biggest and deepest market."

  • Barry Sternlicht, Starwood Capital Group (Bearish on regional banks' exposure to property debt):

    "With regional banks, you wonder what’s going on, like how could they not be experiencing larger losses, certainly in their office portfolios."