Hedge funds are eyeing malls, hotels, and office buildings hobbled by the Covid-19 pandemic in what some say may be the most lucrative commercial real estate move of 2021.
Investors are looking to provide loans and invest in bonds for restructured commercial real estate assets in trades that could be worth hundreds of billions of dollars. Vaccine developments have buoyed commercial real estate, along with other risk assets.
"The distressed loan pipeline is building," Leo Huang, senior portfolio manager and head of commercial real estate debt at Ellington Management Group, said in an interview this week. "This has been a cycle that is so sector-specific that we've seen good opportunity."
Commercial real estate and mortgage-backed securities have become a credit pickers' market, bringing a wide dispersion in performance and losses among deals. Asset selection and credit work in the coming year will be key, market participants say.
"For commercial real estate loans and first mortgages, there's a need to source and underwrite them," Huang said. "It's messy and fragmented. We like that business."
Huang says that his firm will be able to make investments into distressed loans next year. Ellington has been an active buyer of the riskiest slices of transactions known as B-pieces, which are the first to take losses but potentially the most lucrative.
Low, not zero
Property valuations may generally be lower going forward, though there will still be numerous opportunities, said Arena Investors' chief executive officer Dan Zwirn. Assets may need to be fitted with capital structures that make sense for what will now be reduced values.
"We've been very active in participating in the restructuring of commercial real estate assets, in terms of hard money lending, bridge funding, and buying whole loans off of the banks," Zwirn said in an interview. "That trend has only just begun. We want to be a financier of the beneficiaries as much as those in distress."
The CMBS market has struggled this year as Covid-19 kept shoppers out of malls, travelers away from hotels and workers home from offices. But some property segments -- such as warehouses and cold storage units -- have benefited, and even among troubled malls and hotels, there are many that will survive and even thrive, market observers say.
Therefore, investors are not viewing the downturn as black and white, but have a nuanced outlook that assumes certain properties will recover, depending on how well borrowers are capitalized and on a variety of other factors, such as location and demographics.
While retail and hospitality have suffered the most, parts of the multifamily sector may benefit from the move away from cities, while life science research centers, telecom towers, cold storage and industrial properties have all seen an increased flow of business during the pandemic.
In terms of valuations for troubled sectors, it's simply a different world now: there are assets that don't have zero value, but substantially diminished value. "But there's a non-zero value that makes sense," Zwirn said.
While hotels may yet recover, and experts offer varying opinions on the return of urban offices, weaker regional malls, which were troubled even before Covid, may never come back.
"In retail, I think there is real pain, a culling of the weaker assets," said Huang. "Properties that are well located and sponsors with deep pockets and the right demographic zone might be able to survive or reinvent themselves. Otherwise, properties may be turned over to the lender as a deed-in-lieu."
There is a world of assets out there where, ironically, the vaccine is a scary thing, Zwirn said.
"The need for a vaccine could be used as an excuse for short-term poor performance," he said. "When that excuse is removed, and we see what the new world looks like -- especially for retail -- it will be bad." - Bloomberg