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The Search for Yield, Part 2: Refinancing Commercial Real Estate

Post on: October 20, 2016 | Kyle Engelken | 1

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Ten years ago, you could not open your daily financial periodical without being bombarded with articles about the subprime loan crisis. However, quietly in the background, commercial mortgage backed securities (CMBS) were being issued at a record pace with loan to value ratios over 100 percent. In 2005, approximately $169 billion of CMBS loans were issued.

Two years later, this number reached $230 billion. Today, analysts are predicting just $50 billion in CMBS issuance for 2016—far less than the nearly $90 billion in loans due for refinancing this year and over $100 billion in 2017.1 Many of the commercial loans were issued at 10-year terms and the so-called “wall of maturities” has arrived. As a result, there are many opportunities for accredited investors to access private credit funds that seek to close the funding gap created by the supply and demand dislocation in commercial credit markets.

Traditional debt providers such as large banking institutions are limited in the capacity to refinance commercial debt due to regulations requiring lower LTV ratios and a continued aversion to the asset class from the Great Recession. Private Fund managers are stepping in to originate financing solutions for borrowers that are unable to secure funding. In many cases, high performing commercial properties with strong cash flow are unable to refinance with a traditional lender and private fund managers are able to get exposure to high yielding assets with reasonable risk exposure. In other instances, commercial borrowers that are currently “under water” on their loan have decided to forgo property enhancements and any other capital investment aimed at increasing rental income. Fund managers that step in to provide much needed recapitalization solutions to this subset of borrowers can turn around a non-performing asset at attractive terms.2 The supply of financing solutions in today’s market does not match the demand given the CMBS maturity wall. The imbalance continues to provide an opportunity for accredited investors to participate in funding opportunities that offer attractive current income on diversified commercial properties.

Investors looking to allocate capital to real estate have many options. Private investments in core, value add, and opportunistic real estate funds continue to attract billions in capital commitments annually from high net worth family offices, endowments, and other institutional portfolios. Gaining access to quality offerings as an individual accredited investor is not as difficult as it used to be thanks to internet-based private investment platforms. Advisors are getting word of opportunities as they become available, and with minimums well below $1 million, investors can fulfill a commitment without over-allocating to the asset class. While investing in the equity side of a real estate transaction allows investors to participate in upside (and downside, for that matter) valuation potential, real estate debt can offer attractive risk-adjusted returns with current income. Fund managers participating in the refinancing of commercial real estate debt are touting target IRRs between 10% and 15% with quarterly cash distributions.3

The flow of "rescue" financing opportunities on commercial real estate debt should continue well into 2018 as the 10-year fixed rate debt issued during the “bubble” years comes due. High quality properties with outsized debt burdens are in the cross hairs of value-add and opportunistic fund managers. Public markets offer few options with meaningful yield potential in today’s low interest rate environment. Private funds, although illiquid and subject to a broader range of risks, are in a unique position to generate yield for accredited investors.

 

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1 http://www.ccim.com/cire-magazine/articles/323684/2014/11/cmbs-maturity-wave/?gmSsoPc=1
2 Oaktree Capital Management, L.P., “Strategy Primer: Investing In Real Estate”. January, 2016
3 WealthForge internal analysis of commercial real estate credit offerings

Disclaimer: WealthForge provides this information to our clients and other friends for educational purposes only. It should not be construed or relied upon as legal advice.

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About author

Kyle Engelken

Kyle brings a deep understanding of portfolio management and private investments to WealthForge from his tenure at Cambridge Associates. Kyle received his bachelor's at University of Richmond and MBA from the College of William and Mary. Prior to joining WealthForge, Kyle managed a portfolio of microloans in Nicaragua for a US-based non-profit.
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