… at least this forum might get interesting again.
There are still too many terrible sponsors operating (on paper). I don’t think I’m the only one but there are many many groups that I thought would have gone under 2 years ago. Perhaps they will have wished they had but I cannot possibly imagine how those groups will get through this waive of distress. We’re not even talking about only 2021-2022 investments now, 2023-2024 investment in markets throughout Texas have declined 20-30% as well. Crazy to think it was just 12 months ago that there was activity in Texas at 4.5% cap rates.
50%+ declines are now a reality. Grab your popcorn.
The Texas real estate market is indeed facing significant challenges. As highlighted in recent discussions, cap rates have expanded substantially, with guidance blowing out by 100-150 basis points for deals initiated earlier this year. The market has shifted dramatically from the activity seen just 12 months ago, where cap rates hovered around 4.5%. Now, declines of 50% or more are becoming a stark reality.
This distress is compounded by several factors, including rising interest rates, shrinking liquidity pools, and deteriorating fundamentals. Many sponsors, particularly those who invested heavily in 2021-2022, are now grappling with cap expirations, high replacement costs, and flat rents. The situation is further exacerbated by inflated expenses, such as insurance and payroll, and burdensome tax reassessments from peak pricing.
The wave of distress you mention is likely to expose weaker sponsors who may struggle to navigate these conditions. It’s a tough environment, but as some have noted, downturns can also create opportunities for those with dry powder and a proven track record.
Sources: Arbor just foreclosed on $230mm of multifamily in Houston, State of Market Discussion, Downfall of RE, A Discussion on Interest Rates/Macro Fundamentals (Long OP), Coronavirus scare and the impacts to the global economy
50% declines from today’s values?
No no, let's be sensible here. 50%+ decline from peak values. Most markets are reverting back to their 2018/2019 pricing so wherever that was. In some markets, that's a 30% decline while others that's a 60%+ decline. Urban core is a different story, I've seen trades back to 2015-2016 values.
Understood. Yeah I think that 50% from today's values = no chance.
Looking through historic trades are fascinating right now. I’ve seen multiple deals with this profile recently (using round numbers for example):
-2016 vintage sale to Group A for $65M
-2021 vintage sale to Group B for $100M
(group A looks like a genius, multiplied equity and then some - better to be lucky than good)
(group B worked hard to execute business plan but slowly rents stagnated or fell backwards, expenses shot up, newer supply outshined this former Class A building, and now a 10+ year old building is having to offer defensive concessions to stay full)
-2026 marketing: total equity wipeout for group B. Our guidance is the loan balance, but we recognize that yield is thin, negative leverage with where rates are - please bid where you like it bro, this has to trade somewhere…
Question now is will group C look like a genius in due time, or are they catching a falling knife?
If it's cheap enough anyone can look like a genius. A good basis on good real estate will always work out over time unless you radically fuck it up.
As a follow up, I’ve heard of two cases where group A is looking to rebuy their old deal for less than their 2021 sale price. Maybe they really are smart…
In place yield, or at least an extremely clear path to stabilized strong yield, is necessary on anything. Unless you have an investment time horizon of a MINIMUM of 10 years and a capital structure to match, don’t even think about relying on the “but but it’s XX% below replacement cost”.
It’s like the saying in equities, “Markets can remain irrational longer than you can remain solvent.” There are plenty of irrational developers still out there and it’s pretty clear this cycle is going to take fooooorever.
Four years ago, the common narrative was "survive until '25." Halfway through last year my wife, who isn't in the industry, said it's starting to look more like "wait til '28." Given how things are slowly shaking out, who knows if there will be much meaningful change over the next year and a half. I'm trying to be optimistic but wonder if the 2020s will be looked back upon as the crash & burn (or lost?) decade in CRE.
It wasn't long ago where folks on here said distressed deals were coming across their desk, but their underwritten numbers were below the notes' current values. I'd venture to guess that lenders haven't taken back more keys for this reason, and they don't want to get stuck with an underperforming asset if they don't have to. I'm assuming you're seeing distressed deals come across your desk- in general, what do they look like? Are groups starting to sell if they can dump the asset/ note, and take their equity loss? Are brokers actively marketing discounted properties, or you're seeing the deals from a different source? Any POV is appreciated, I realize I'm asking loaded questions.
I think lenders are starting to push more for realizations, but outside of office, I'm really only seeing that on deals where the lender is in the money. A lot of lenders (and particularly banks) are okay with borrowers continuing to trudge along because: (1) relationships matter to them, (2) acknowledging a problem with one asset infers problems with every other asset that looks like it, and (3) if you get the money back, what are you going to do with it? It's competitive as all get out right now on the lending side of things. It's a weird market we are living in...sale processes are touch and go at best, but debt markets are very frothy.
Distressed deals have definitely picked up. Saw my first 2023 acquisition priced below the loan principal. Without a question, it's picking up and to CRESF's point, the only thing even remotely holding together the market right now is the fact that credit is still tight which allows a good percentage of lenders to not take back properties. If you have debt coming due, you're at a minimum looking at a very significant cash in which has become harder to accomplish. The doom and gloom predictions that has made since 2023 are coming true, it's just taking 5 years longer than anyone expected. 2028 probably the best case scenario, in my opinion.
If you can believe it we are building in Texas right now. Juicy basis… we will see how it performs.
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