As the commercial real estate market gears up to tackle a heavy year of loan maturities, there is a dearth of people to fill a critical function: working out loans.
There are about $659 billion of loans slated to come due in 2024, with another $539 billion maturing in 2025. And market participants who spoke with affiliate title Real Estate Capital USA said there has been a notable increase in lenders and borrowers seeking to resolve situations of distress.
“It is pretty apparent that there are a lot of investments made over the past few years that have issues with the debt,” said Kent Elliott, a principal at Newport Beach, California-based executive search firm RETS Associates. “There are scores of examples of developers with loans coming due and who are seeking short- to medium-term solutions.”
The problem, however, is that the workout skill set has fallen dormant in the years since the global financial crisis.
“No one under the age of 35 has experience in this space,” Elliott said. “As distress becomes more prevalent with banks and financial institutions, finding the talent to handle these workouts is going to be challenging. You can just say, ‘I want someone who has been doing this for the past five years,’ but there is no one who has been doing this during that time.”
Workouts in progress
Danielle D’Ambrosio, head of real estate debt asset management for Charlotte-based investment manager Barings, said the firm is expecting to see workouts rise in the coming year and lenders and borrowers confront the looming wall of maturities.
“When we started this year, we knew it wasn’t going to be easy. In debt asset management, we modified more than $3 billion of loans this year and borrowers put in more than $100 million of equity. We realised zero impairments and did not subordinate a dollar of debt.”
D’Ambrosio noted a key difference between working out loans today and during the financial crisis: the interest rate environment.
“We were helped by interest rates in the global financial crisis and the conversation around value was very different than the conversation about value today,” D’Ambrosio said. “We have used the lessons of the past to originate over the past 15 years and that has resulted in strong borrowers with strong properties and cashflow. We never really went back to the loose credit standards that you saw across the market.”
The other factor that has helped Barings specifically has been the firm’s focus on both debt and equity, D’Ambrosio added.
“We are not like a traditional bank in that we can take a property back, create a business plan for it, and hold it for as long as our clients want. Having that stick from a negotiation perspective and the carrot of being empowered to work things out helps us work with our borrowers, if they perform and act appropriately,” D’Ambrosio said. “In a good negotiation, no one is happy, but everyone understands where we had to get to, and we worked towards that for both parties.”
Finding workout specialists
For RETS Associates, some of the conversations the firm is having today are around finding flexibility in hiring.
“We are talking to clients about the need to be flexible, to hire someone who has done a similar function but maybe hasn’t done an actual workout,” Elliott said. “In 2010, there were a lot of equity asset management professionals that went over to be on the special servicing side to be workout specialists. The skill sets that a general asset management professional has can evolve to fit this need.”
Additionally, the firm has been looking at recently retired workout specialists to see if they are interested in coming back for one more cycle, Elliott added.
“Can we find those people? Yes. They haven’t been doing that work for the past number of years, so we have to go back to previous cycles to find them and the question becomes if they want to come back.”
The impact of succession planning is also being felt, with Elliott noting a number of senior workout specialists are moving into higher-ranking positions in their firms.
“When you look at the retirement of Baby Boomers leaving the workforce, it is accelerating and their departure – planned or unplanned – creates succession planning opportunities. If you couple that with challenges we have experienced with the pandemic, the people who said, ‘I’ll get us through covid and then retire’ are now faced with this capital markets issue. Does this become one more reason for retirement?”
Ultimately, real estate is a relationship business and people have long memories of how they were treated in up and down cycles, Elliott said.
“Some of the deals that I have heard about going back to the lender, it has been resolved as amicably as possible, which is not the worst-case scenario for the borrower. It is probably not ideal, but the best case in the situation. I don’t have an anecdote about a cold-hearted lender, but I do believe those exist.”
The market is slated to see a substantial number of maturities coming through in the next year. Critical to this is that liquidity – both debt and equity – comes back into the market to the point where borrowers can refinance.
“If you believe that rates are going to start to come down, especially on deals that are SOFR-based, you’ll be able to lock in a fixed-rate deal and feel better about it,” D’Ambrosio said. “From the borrower perspective, you are starting to see some trades. They are distressed trades, but they are starting to give the market some idea of values. We started having conversations in 2023 around value, but they were theoretical. This year, they won’t be theoretical.”
Going forward, debt will continue to play a critical role in the workouts and restructurings, D’Ambrosio said. She recounted a situation in which Barings was meeting with brokers about the current market.
“One of the brokers said, ‘How do you spell equity today?’ and the answer was ‘D-E-B-T.’ We have a unique opportunity at Barings where we look at markets and research to drive our debt and equity investment decisions and when it does come to a difficult situation with a borrower, we likely have assets in those markets and have a team on the ground doing deals every day,” D’Ambrosio said.
The question of when rates will moderate is a critical one for the market. “We would hope that, 12 months from now, rates will be down but bridging that gap is going to be a challenge for everyone,” Elliott said.
Barings’ D’Ambrosio concurred: “The first meeting of the US Federal Reserve will be a true test of whether real estate will come back.”