Hypothetical - what do REPE funds do now?

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.

 

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...

 
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.

 

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.

 

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?

 

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.

 

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.

 
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.

 

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.

 

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)

 

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).

 

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.

 
Most Helpful

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.

 
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
 

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.

 

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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