The private real estate industry has been anticipating distress since the start of the pandemic. But as governments passed emergency measures to keep the economy afloat, the prospect of widespread distress receded.
But the specter of large-scale distress has returned as the macroeconomic environment has become increasingly volatile. Three partners at global law firm Proskauer offered their thoughts on what is to come in an exclusive conversation with affiliate title PERE‘s editor Evelyn Lee. Proskauer hosted the conversation at its New York offices.
“I think probably in the next six to 12 months, we’re going to see a big uptick in distressed opportunities and situations that will continue to deteriorate,” Jeff Marwil, US co-head of the firm’s business solutions, governance, restructuring and bankruptcy group, said. He attributed the uptick to “the confluence of all the macroeconomic events”, including inflation and rising interest rates.
Steven Lichtenfeld, co-head of the real estate capital markets and real estate finance groups, agreed that distress will emerge but will be concentrated in asset types that already face challenges – central business district hotels, class B and C offices and non-essential retail, he said. Property types that fall into the ‘beds, sheds or meds’ categories are unlikely to see a lot of distress.
Government intervention helped to stave off an initial wave of distress. Vincent Indelicato, a partner in Proskauer’s business solutions, governance, restructuring and bankruptcy group, said there was a two-week window of distress in 2020 before Washington intervened with emergency relief measures that helped a lot of borrowers hold onto their properties. If it were not for this injection of liquidity, lenders may have been more opportunistic in taking control of assets rather than extending forbearances and working with borrowers.
Some of the forbearances are starting to “roll off” and work its way through the system, Indelicato said. He added that significant macroeconomic headwinds, along with the uncertainty around the war in Ukraine, will put considerable strain on already struggling businesses.
“I think that will just intensify the dance between sponsors and lenders around what comes next,” Indelicato said. “We hope to have a front row seat.”
The window of opportunity for distress will depend largely on whether there will be a recession. If an economic slowdown does occur, “the cycle of reworking these businesses and dealing with the distressed assets could be a couple of years”, Marwil said. “If a recession doesn’t happen, the level of distress probably won’t be particularly severe. And it probably won’t take as long to work through to the other side.”
If a recession did materialise, distressed opportunities could arise from “a lot of complicated assets and complicated capital stacks,” Lichtenfeld said.
The biggest headwind is inflation and its impact on consumer spending and the economy, he noted. That – combined with interest rate increases by the Federal Reserve, which raised rates by 75 basis points last week – could trigger a recession.
“Undoubtedly, it’s a careful dance that the Fed is going to have to play here in terms of getting inflation under control and at the same time not creating a recession,” Lichtenfeld said. “I think it’s TBD on that.”