Hypothetical - what do REPE funds do now?

Investment Analyst in PE - Other

In light of these down markets, let's say this virus launches us into a recession. A recession not caused by overblown real estate values.

What do private equity/debt funds do in an environment like this? How does the strategy change? Is it a just wait it out and see?

This doesn't seem like a situation where there's be boat loads of NPL portfolios hitting the market, maybe not as many distressed properties to buy up, but I guess I could be wrong there. What's the play?

Maybe someone who was in repe during the dotcom bubble could enlighten us on RE plays through that crash.

Comments (96)

Mar 9, 2020

If anything I think real estate is one of the safest sectors right now. Look at REITs compared to the rest of the market today. Growth obviously slows and retail/hospitality will get hammered but the yield will be way more attractive on a relative basis in products like apartments and industrial. Buildings with high WALE are worth their weight in gold.

Also - a credit crunch/liquidity trap scenario is exactly when you'd expect under-performing properties to start hitting the market...

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Mar 9, 2020

What is 'WALE'?

Mar 9, 2020

if they meant WALT, then weighted average lease term.

Mar 9, 2020

WALE = weighted average lease expiration/expiry. Interchangeable with WALT

Don't @ me

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Funniest
Mar 13, 2020
applestw0apples:

What is 'WALE'?

Wale is an American rapper from Washington DC. He would probably be best known on WSO for his hit featuring Rick Ross, "Ambition."

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Mar 10, 2020
decrebepro:

If anything I think real estate is one of the safest sectors right now. Look at REITs compared to the rest of the market today. Growth obviously slows and retail/hospitality will get hammered but the yield will be way more attractive on a relative basis in products like apartments and industrial. Buildings with high WALE are worth their weight in gold.
Also - a credit crunch/liquidity trap scenario is exactly when you'd expect under-performing properties to start hitting the market...

Yea bro - am loading up on some 20 year WeWork leases - weight in gold! Because when the economy turn they'll never walk away from that long lease! What about all the other companies who will be experiencing some level of bankruptcy as PE fund loaded them up on cheap debt with rock solid ICR ratios of less than 1.

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Mar 10, 2020

Holy shit this guy is a genius. Nobody has ever thought to evaluate credit risk when looking at leases. Bravo sir, you've just revolutionized the industry.

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Mar 12, 2020

Youve been reading the news a little too much it sounds.. Id love to know which landlords/projects are signing 20 year WeWork leases

Mar 27, 2020

When you look at a single tenant building, the credit is what matters. But when you look at multi-tenant buildings where nobody is more than 20% of the building, then WALT is more focused on than tenant credits.

A building with 10 private credit tenants with good operating history vs. a building with 7 BBB rated tenants and 3 start-up companies, I don't think the latter is a clear winner.

WeWork though, if a building is 100% leased by them, I would avoid at all costs.

  • Analyst 1 in RE - Res
Apr 7, 2020

The idea that commercial property w/ higher WALE/WALT being safer during a recession makes sense to me; however, wouldn't a major caveat to that metric be that it doesn't take the risk of tenants seeking rent relief/default risk on their rent payments into account, correct? And couldn't you expect that to happen in the next few months for commercial property, particularly retail?

Mar 9, 2020

Edit: all good, @BMCM

Mar 9, 2020

Just quickly opened several tabs and wanted to follow this one without noticing it was on top, no worries I'm 100% mammal

  • Intern in IB - Gen
Mar 9, 2020

There is no recession- it's just a panic. Markets will recover from coronavirus in a few months time- max probably 5 months. As for the recent drop in crude prices, this entails cheaper resources for most companies (airlines, etc.). Real estate will be fine, as for every industry unless you can think of a specific reason as to why it will be affected, it will be fine.

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Mar 9, 2020

To play devils advocate... the us economy is largely driven by consumer demand and cheap shit from Asia. If people are afraid to go out and travel and our supply chain is disrupted in Asia it will have a ripple effect on every sector of real estate. Hospitality, retail, industrial could all see primary effects while MF could see secondary effects due to layoffs as companies start to fold and payrolls fall.

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Mar 9, 2020
Intern in IB - Gen:

There is no recession- it's just a panic. Markets will recover from coronavirus in a few months time- max probably 5 months.

So in other words, there will be a drop in GDP for 2 straight quarters.

Also known as the literal textbook definition of a recession.

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  • Intern in IB - Gen
Mar 9, 2020

Lmao I'll concede, I was thinking more so along the lines of a major recession (I grew up in the financial crisis era so that's what comes to mind), but you're right that it "technically" could become one using the more explicit definition of the word in terms of economics.

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Mar 9, 2020
Ozymandia:

So in other words, there will be a drop in GDP for 2 straight quarters.

Make recessions great again

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Mar 9, 2020

Spoken like a true intern.

Don't @ me

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Mar 9, 2020

I'd expect everyone is pausing their acquisitions for a month or two.

Mar 9, 2020

Nah fam, you seen these rates lately?

Mar 9, 2020

Rates are lower but lenders are definitely increasing their spreads right now.

Mar 9, 2020

Why?

Mar 9, 2020

From what I understand, As rates decrease lenders put a higher spread on their loans because if rates move up significantly and their spreads are too low they could be out a lot of money in the securitization process.

Mar 25, 2020

We had a call with a national multi family brokerage (CBRE, cushwake, etc.) Tuesday and buyers fall into three buckets; half are putting every thing on pause, another quarter are actively looking but are asking for 1-5 percent discounts because of the uncertainty, and another quarter that are predatory/opportunistic and waiting for distressed situations.

Mar 25, 2020

True. All debt brokers are saying the same thing, and personally we fall into all 3 buckets. I think most people are waiting to see what happens next week.

Half of you says: nothing has fundamentally changed, the asset is still a good buy, and this will work itself out

The other half: Okay, but what happens if the class B/C tenants just dont pay for 3 months, and stimulus runs out if it comes at all, and the insurance company and bank are knocking on your door?

Then the other other half says: what the above happens, leading to repricing of the asset, even by 5% or so; so now you're in an asset x% above market rate, with no ability to create value for 1-2 years, and in fact you are navigating maintaining current value, in order to hope to return capital at ~8%, when your competitors held cash a few months and were able to create alpha, and now your investor is asking why?

The prudent choice is definitely to sit and wait it out a few weeks, but real alpha will be realized or you'll lose a lot in the very near term. I dont think my capital, personally, is going to pull the trigger soon tho (like in a week or two)

Mar 9, 2020

We are proceeding business as usual. Pausing on some markets that we think will be more volatile (Houston and Orlando), and running more downside scenarios as part of our underwriting/investment documentation for all other deals.

My concern is 1) debt markets/liquidity and 2) fundraising/investor appetite in the space (though, given the alternatives, I would bet most institutional investors allocate more to the space).

Mar 9, 2020

I get pausing on Houston due to oil prices dropping, but why Orlando? Not as familiar with that market.

Mar 9, 2020

I'd guess because the local economy is very tourism heavy, just as houston is very O&G heavy. Not sure how much the coronavirus would affect things like MF long-term, but hospitality is likely in for a nasty time for the next couple quarters.

Mar 19, 2020

REPE could be seriously affected if this situation gets drawn out enough for businesses to start shutting doors. RE income is not linear so losing tenants usually creates a large "step down" from the previous income. RE would probably be the last domino to fall, but if it does it probably won't be able to be stopped

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Apr 5, 2020

This

Most Helpful
Mar 19, 2020

REPE shops with a flexible mandate will temporarily down tools on private market auctions because capital markets have dried up and they can't get the leverage they need to hit their returns. They will start screening public market opportunities where the underlying sector won't get hammered (like retail or hotels) but where the company may need liquidity soon (e.g. large bond repayment in 2020 but not enough cash and no refi options because financing markets are on hold). You don't need to take the company private but can just carve out a part of their portfolio for a discount and provide them with the cash they need. They may have to stay unlevered but given the discount their day-1 yield will be higher and this will hurt less. Then refi once markets stabilise. This is how prudent PE shops should be making money now - not buying stabilised real estate in auctions and betting on yield compression.

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Mar 25, 2020

you would need a shit load of equity , and very flexible IC to execute this no?

Not saying it is wrong at all, but this would take an absolute shit load of capital to pull off unlevered ... and big nuts

Mar 26, 2020

I agree. My last shop is definitely doing that. But as you say you need flexible IC (potentially distressed focus) and funds in the billions.

Mar 26, 2020
surrealassets:

They will start screening public market opportunities where the underlying sector won't get hammered (like retail or hotels) but where the company may need liquidity soon (e.g. large bond repayment in 2020 but not enough cash and no refi options because financing markets are on hold). You don't need to take the company private but can just carve out a part of their portfolio for a discount and provide them with the cash they need. They may have to stay unlevered but given the discount their day-1 yield will be higher and this will hurt less. Then refi once markets stabilise.

good stuff!! thanks for this one

  • VP in S&T - FI
Mar 24, 2020

For any debt fund guys out there with capital and no deal flow, at what point do you start buying CMBS Bonds. What is sort of the yield/spread target on bonds (assuming you can't get financing from a dealer b/c dealer balance sheets are mostly tapped) are you looking to hit?

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Mar 28, 2020

what about REPC? when private capital halt on lending; have you seen any property managers running out of cash already?

  • Incoming Analyst in PE - Other
Mar 29, 2020

For larger sponsors using a fund structure there are a few options: draw down on lines of credit, call additional capital (usually only ~95% of committed capital is called during investment period), or obtain capital from other debt sources (bridge loans, etc...). It is the smaller managers who do not have access to these sources who will be hurt if they experience large credit losses and/or vacancies as lenders (direct lending) has dramatically slowed/stopped financing.

The property managers aren't going to run out of cash because managers can just defer capital improvements/maintenance. The risk is more on the side of covering debt service/maintaining debt service coverage covenants.

Mar 30, 2020

Thank you this is quite helpful.

REITs like Redwood and New Rez are getting hit so hard rn..

Apr 3, 2020

Agents are saying everything is fine, vendors think their land / asset is still worth what it was 2 months ago, and bank are too busy dealing with liquidity / covenant issues for operating assets (hotels or leisure) to lend. Trying to price stuff is difficult when people have no idea what the impact from Covid really will be.

For REPE funds which have the ability to invest in public RE opportunities (REITs or RE backed companies) it's a very interesting time as there are companies where the sell off does not stack up with the value of the underlying assets.

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Apr 3, 2020

For REPE funds what should they look at when determining which REITs to double down?

If you look at AG MIT and MFA they look pretty bad and will it be a good investment?

Apr 3, 2020

I'm not familiar with either as I'm Europe based.

I like REITs where market cap is below 1bn and the portfolio consists of less than 20 assets. It allows you to do a deep dive of the portfolio and assess whether the sell off is driven by fundamentals or if the stock is going down with the tide. There's a lot of REITs which are down 30-40%, but when you look at the credit profile of the tenants and the quality of the assets it's hard to justify such a drop in cap values. These present pretty attractive opportunities to buy in and see a recovery to 80-90% of pre-Covid value once we've weathered this crisis and the income stream is proven.

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Apr 6, 2020
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Apr 3, 2020
Apr 5, 2020