Distressed debt is still the exception not the rule

In late March, Oaktree Capital Management announced the $4.7 billion final close for its largest-ever property fund, Oaktree Real Estate Opportunities Fund VIII, far exceeding its original $3.5 billion target.

One of the most notable aspects of the announcement was that the Los Angeles-based manager had already invested or committed approximately 40 percent of the fund’s capital at the final close. That share has been designated for what Oaktree head of real estate John Brady called a “compelling set of credit-focused investment opportunities”. Although the ROF series is invested in both equity and debt, a document from the Nebraska Investment Council identified ROF VIII as an “opportunistic credit distress fund” targeting distressed debt acquisitions, equity recapitalisations, rescue financings and discounted securities purchases.

The quick deployment, which Oaktree began investing at the start of the pandemic, is not indicative of real estate debt distress overall, however. In a debt-focused roundtable in March, affiliate title PERE heard four managers discuss the potential opportunity in distressed real estate debt. But while some expected to see distressed dealflow pick up, particularly from hospitality, the participants agreed very few opportunities had materialised to date.

As one UK-based firm said: “We’re still in furlough and most distress has been kicked down the road.” Meanwhile, a US manager noted there had been very little enforcement by lenders on borrowers in default so far, and consequently he was not seeing any actionable opportunities.

Far from the peak

Distressed assets have been trading during the pandemic, but represented just $1.4 billion, or 1 percent of sales, in Q4 2020, according to data provider Real Capital Analytics. Moreover, distress has remained below 5 percent of total asset sales since 2016 – far from the more than 20 percent of total sales during the peak year of distressed asset sales in 2010, per RCA data.

What explains the robust flow of actionable opportunities on which Oaktree says it is capitalising? One US-based roundtable participant said he had been discussing the Oaktree fundraise and believed the manager’s track record has played a significant role in its ability to access deals. Its 2015-vintage ROF VII was generating a 39.6 percent net return and a 1.3x net multiple as of December 2018, according to a document from the Plymouth County Retirement Association. So has its reputation for being “a little more creative and specialised” than competitors.

Among fellow mega-managers, Oaktree has consequently carved a niche, the US manager noted. Such attributes have given the firm a competitive advantage in a space where there has so far been much talk, but little action.

The firm is applying this advantage to a small window of opportunity. The PCRA document noted the strategy “is positioned to transition away from distress towards growth-oriented opportunities” as the economy recovers.

RCA reported outstanding distress – meaning troubled loans currently in special servicing – of $55.6 billion and potential distress of $90.5 billion as of year-end 2020. Many distressed real estate debt players are still waiting for that outstanding and potential distress to turn into buying opportunities. By then, Oaktree will have likely already pivoted to the next stage of the cycle.