What Makes Today’s CRE Capital Markets Unique—and Why It’s Important
Whenever the commercial real estate (CRE) market hits a rough patch, analysts inevitably talk about how “this time is different.” It’s natural to look at prior downturns to figure out what kind of analogies we can draw and if there were any valuable lessons learned. The October 25th episode of the LightBox CRE Weekly Digest podcast featured guest speaker, Brian Olasov, executive director at Carlton Fields and 2024 Recipient of the CREFC Founders Award, a well-known expert on capital markets and business strategy. Olasov outlined the myriad ways that today’s CRE market is different than past downturns—and how it’s the same. Below are highlights from the discussion and why it matters to CRE professionals as the next stage of the cycle unfolds.
- Data-Driven Expertise Matters Now More than Ever
We’re not in “blue sky” territory anymore like we were in the days of zero interest rate policy in the last few years leading up to the Fed’s ratcheting up of rates. Back then, everyone was in agreement, in today’s market, property-level data and expertise are needed to support better outcomes. It’s an opportunity for CRE professionals to deliver value and support smart decision-making rather than just being order takers.
- Averages Aren’t as Meaningful as They Once Were
None of the economic rules of thumb that used to ‘fit’ the data apply to the post-COVID market. We have a lot of different contrary indicators. The Phillips curve, which is the relationship between inflation and unemployment, is just one example of a past theory that doesn’t necessarily hold true anymore. In today’s differentiated market, you must be very cautious about applying conventional wisdom. You can’t generalize by geography or by property types, and market averages aren’t as meaningful as they used to be. There are wildly disparate outcomes at the property level, so it’s very misleading to talk about average performance in retail or average performance in Dallas, Texas, for example. It means that experts have to be extraordinarily discriminating and tap into data at the property level, and on the sub-market level.
- Banks Have Leverage as Borrowers Seek Capital
It’s at the bottom of every crisis that banks should start lending, but back in the Great Financial Crisis (GFC) of 2008, it took three years after the recession for Commercial Mortgage-Backed Securities (CMBS) delinquency rates to hit bottom. Lenders moved in when they had no leverage over the borrowers and financial conditions were loose. But today, it’s a lenders’ market where borrowers are scrambling for capital. Banks have leverage—and an opportunity. Lenders can be price givers and borrowers the price takers.
“If you have the opportunity and the capital and at least some level of patience, I think we’ve learned historically that this is the point in the cycle when banks can make great, durable loans under very attractive terms.”
– Brian Olasov
- The Snowplow Effect is Prolonging Loan Maturities
In 2016, the market was hit with the wall of maturities from the 10-year loans made during the market’s 2007 explosion. There were loans at 6% debt yields that should not have been refinanceable but they were being refinanced by community and small regional banks who reduced the wall of maturities. But today, the default resolution by banks is to extend loans by another 12 or 24 months, creating a new phenomenon called the Snowplow Effect. This means the maturities aren’t managing down, they’re growing, and there’s no “white knight” in the form of commercial banks that are going to step in and support refinances. In the Resolution Trust Corporation (RTC) days, the market found its footing through an active secondary market trading in non-performing loans (NPL), that gave banks an avenue for clearing their books. Last year the market was frozen, so no one was bringing NPLs to market which also stalled price discovery, creating another unique challenge today that there’s a lack of comps for getting variables like net operating income (NOI), operating expenses, and cap rates on a property. Today’s market is going to have to work itself out of this over time with a lot more pain.
- Rising Operating Expenses Demand Smarter CRE Management
It’s time for asset managers to shine. In the past, operating expenses weren’t much of a focus. You’d calculate revenues based on lease abstracts and occupancy assumptions, then just take operating expense numbers for the trailing 12 months and grow them by 2% per annum. Today operating expenses have gone up exponentially, especially for property insurance and especially if you have a coastal property. Insurance costs alone are going up as high as 50% or more a year so what we’re seeing for the first time are defaults precipitated just out of increases in operating expenses. What it means is that as an investor or lender, you need to be more discriminating. Property managers and owners need to be diligent in managing and controlling expenses and financials. The past few years have allowed lenders, developers, borrowers, and managers to get complacent. Now they have to be active managers on all levels in order to be successful.
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