Join us for a lively discussion with Dr. Ben S. Bernanke. The CEOs of Marcus & Millichap and TruAmerica Multifamily are honored to host a comprehensive discussion with the former Federal Reserve chairman spanning the economic outlook, ramifications of the election results and factors impacting commercial real estate.
Wednesday, November 18, 2020 1:00 p.m. Pacific/4:00 p.m. Eastern
Distress Investors May Have to Wait as Long as 3 Years for Non-performing Loans to Come to Market
Distress investors have been racing to the market in anticipation of snapping up deals. For the most part, they are finding, to some chagrin, that there are little properties and loans available at deep discounts. There has been much posting about when these transactions will come to market—the end of summer and the fourth quarter are two popular timelines—but a better question might be to ask, why are there no distress deals available now? That answer in turn becomes a straight line to the question of when.
CBRE analysts believe one major reason for the lack of distress on the market is that most lenders, outside of CMBS, are being very accommodative to troubled borrowers.
And even some CMBS borrowers have been able to navigate the structure’s complicated rules to gain loan forgiveness. Urban Edge Properties, to cite one example, just announced it has completed the refinancing of its mortgage loan for The Outlets at Montehiedra, in San Juan, Puerto Rico. The existing $119 million CMBS loan consisted of an $83 million senior note and a $36 million junior note. The $36 million junior note will be forgiven, according to Urban Edge, and the senior note will be replaced by a new ten-year $82 million mortgages provided by Banco Popular de Puerto Rico.
In short, whether the lender is a bank, conduit, debt fund, or life company, we are in an era of forebearageddon—a coin termed by Brian Stoffers, global president of CBRE’s debt and structured finance group. Stoffers used the phrase during a webinar recently hosted by CBRE.
Banks, in particular, have been having constructive and accommodative conversations with clients and they are more likely to keep troubled loans and properties on their books, he said during the online event. “I don’t think we will be seeing large, distressed transactions coming out of the banks.”
Loan sales as well, while they have picked up materially, are seeing few signs of distress, Patrick Arangio, vice chairman of CBRE’s national loan and portfolio sale advisory, also said during the webinar.
“Buyers have been reaching out to us, expecting a glut of non-performing loans,” Arangio said.
But the type of sales that are happening are typically portfolios backed by assets that were less favored before the pandemic, he said. The properties might be functionally obsolete, be older boxes, have poor window lines, or maybe in secondary locations within their markets. Arangio believes that these investors will start to fixate on these shortcomings in ways they did not before COVID-19 and they will eventually come to market.
Other loans are being sold for liquidity, he continued. Then there are those loans that, while paying in the short-term, are expected to experience a downturn at the property level. Some of these are coming to market, he noted.
Arangio as well points to the thoughtful approach lenders are taking in negotiations with borrowers and he expects this to continue for some time. How long exactly? That is the billion-dollar question, Arangio said.
There is no easy answer because, besides lender forbearance, the property markets are also being supported by government relief programs and the federal expansion of the unemployment program, which is being used by many apartment dwellers to pay their rents.
It is hard to say when these programs will be stopped and when lenders will become less forgiving with forbearance, Arangio says—and how that will impact the distress loan market.
His best guess: “We expect the expiration of forbearance may lead to a material increase in non-performing loans in the next 36 months,” he says.
Source: GlobeSt By Erika Morphy | June 03, 2020, at 04:26 AM
COVID -19 has disrupted the normal market equilibrium of supply and demand, creating a unique window of opportunity for attracting exchange-motivated capital.
Despite commentary suggesting a stalled transactional market, Marcus & Millichap has seen near-record levels of closed transactions in 2020. As the 1031 exchange market leader, we know that nearly 40% of these sellers will become buyers.
Moreover, the health crisis has slowed new listings, further amplifying the opportunity for sellers to capitalize on the imbalance in place today.
Marcus & Millichap has the industry’s largest sales force of commercial real estate advisors and long-standing relationships with private clients, the primary source for 1031 exchange capital. Contact ustoday to take advantage of the small window for tapping this unique market opportunity.
Section 1031 of the Internal Revenue Code enables real estate investors to defer capital gains on income-producing property when those gains are used to acquire a like-kind investment. Colloquially, a 1031 exchange is the transaction in which an investment property is liquidated and the proceeds from the sale, including capital gains, are used to acquire additional income-producing property or properties. For the exchange to meet IRS standards, buyers have 45 days from the initial sale to identify a replacement property of equal or greater value and 180 days to acquire that asset.
In an effort to relieve pressure on 1031 timelines while much of the country is shut down and lenders are focused on processing thousands of loans initiated under the CARES Act, the IRS has temporarily altered the requirements to meet its standard. Under the new guidance, both the identification and acquisition of the replacement property or upleg, has been extended. If the identification deadline falls between April 1 and July 15, the new deadline is July 15. Likewise, if the 180-day purchase deadline falls between April 1 and July 15, the new deadline is moved to July 15. Further guidance from the IRS may be necessary due to a conflict with existing rules in Section 17 of Rev. Proc. 2018-58 that extended 1031-exchange timelines during a federally declared disaster.
The implications of the altered guidance will impact all stakeholders active in the 1031-exchange market, including a significant number of investors already on the upleg of a transaction. Shelter-in-place orders slowed the pace of closings, which could have left some investors responsible for capital gains taxes despite identifying a replacement property and attempting to purchase the asset within the allowable window. As investors seek clarity on conditions, some identifications may be delayed until closer to the July 15 deadline, creating a potential new bottleneck on intermediaries.
Investors will welcome additional breathing room at a time when most steps in the process are taking additional time. The pressure on buyers to identify a property that will close quickly rather than one that meets investment goals has been alleviated, and longer due diligence periods may change the type of attractive properties they can identify. It reiterates to sellers that the investment market continues to close transactions despite headwinds. Furthermore, the attractiveness of existing available properties may change as buyers reevaluate post-pandemic conditions.
As the new coronavirus (COVID-19) broke free from China, the prospects of increased economic risks drove Wall Street into a flight to safety. Over the course of the following three weeks, the S&P 500 index fell 30 percent and pushed the 10-year Treasury to a record low, briefly touching 0.42 percent on March 9. Since touching that intraday low, the Treasury rate has been on an upward trajectory. Market turbulence remains elevated, with the volatility index reaching its highest level on record. This has reiterated the comparative stability of real estate investments, while the record-low interest rates have sparked an increased appetite for acquisitions and a wave of refinancing activity.
Federal Reserve takes decisive action to sustain market liquidity
To invigorate the economy during this period of uncertainty and pro-actively ensure capital markets do not lock up domestically or internationally, the Fed has taken swift action. On March 3, the Federal Reserve made an emergency 50-basis-point reduction to the overnight rate and later committed to more than $1 trillion of Treasury purchases and repurchase agreements. Following President Trump’s declaration of a national emergency on March 13, the Fed followed with an additional 100-basis-point cut and a commitment to $700 billion of quantitative easing. This takes the Fed funds rate back the 0-0.25 percent range, where it was through much of the Great Recession, keeping the interest rate climate low to fuel spending to support economic growth. While the Fed’s action has been so swift that it caught Wall Street by surprise, creating short-term volatility, it has also demonstrated the commitment to getting ahead of the biggest financial market risks.
Real estate investments deliver outsized long-term returns
While the stock market delivered exceptional total returns in excess of 25 percent last year, the recent correction has demonstrated how much volatility risk goes with that yield. Comparably, real estate investments averaged a total return of 7 percent last year, but without the whipsaw, repricing experienced by Wall Street. Comparing the two asset classes over the long term demonstrates the advantages of real estate. An investment made 20 years ago, at the beginning of the year 2000, has delivered dramatically different results. The average total return on commercial real estate over this time has topped 359 percent while the stock market has delivered a 115 percent return. Even without considering the recent stock market correction, real estate outperformed.
Financial Market Trends
Wall Street downturn significant but moderate compared with past corrections
Over the course of three weeks, the stock market fell by 30 percent with dramatic single-day moves both up and down. While the new coronavirus sparked the selloff, the stock market was particularly vulnerable to a correction. Over the course of 2019, the stock market valuation increased to a record level that was not substantiated by comparable earnings in the 12 months leading up to the virus outbreak. By comparison, the stock market fell by 56 percent during the financial crisis in 2007 and by 49 percent in the early 2000s as the dot-com bubble burst. Though this downturn is significant and has yet to fully play out, much of the current momentum is fear-driven. As additional information and clarity emerge, market dynamics should begin to stabilize.
Record-low interest rates boost investor returns
The flight to safety placed strong downward pressure on interest rates, pushing the 10-year Treasury to an all-time low. Investors have responded with a surge of refinancing activity and an increased interest in acquisitions. Total refinance activity surged in the first week of March, climbing by 79 percent over the last week of February. Numerous buyers also capitalized on the unique timing to lock in rates in the high-2 percent to low-3 percent range. While investors can still capitalize on low rates, many lenders have opened their spreads to moderate their downside risk. The low-interest rate climate will help investors achieve stronger levered yields as the spread between the 10-year Treasury and average cap rates set a new 30-year record.
Yield spreads offer unique investment climate
While investors often anticipate buying properties at reduced prices during periods of uncertainty, similar results can be created by locking in lower interest rates. Obtaining an exceptionally low-interest-rate generates a stronger yield as positive leverage delivers the upside. If an investor borrows money at 3 percent to purchase a property with a 5 percent cap rate, their 2 percent arbitrage lifts their levered yield significantly. While some investors go to the sidelines and await market clarity, others are maximizing their returns by locking in a lower cost of capital.
Contact Marcus & Millichap to discuss how we can assist you to evaluate your portfolio and commercial real estate investment needs
Real estate less volatile compared to the stock market
Ability to source debt boosts leveraged returns
The broad range of sectors offer investors options
*Commercial real estate total return includes apartment, retail, office, & industrial properties $1 million & greater; includes non-leveraged weighted average returns on property price appreciation & cumulative cash flow S&P 500 total return based on price index appreciation & cumulative dividends (dividends not re-invested) Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Real Capital Analytics, Standard & Poor’s*