CONTRIBUTORS
Tony Davidow, CIMA®
Senior Alternatives Investment Strategist
Franklin Templeton Institute
In our latest episode of the Alternative Allocations podcast series, I had the opportunity to sit down with Richard Byrne, President of Benefit Street Partners, to discuss opportunities in commercial real estate debt. We examined challenges facing real estate broadly, from falling valuations to the disruption in the office sector.
Rich believes that the disruption in real estate creates unique opportunities to be a lender, especially since banks will likely be hesitant to lend to these troubled assets in the future. He described the depth and breadth of opportunities his firm is seeing—from construction loans to mezzanine to CMBS (commercial mortgage-backed securities). While office valuations have come down, Rich believes they will likely fall further before he considers them reasonably priced.
Rich had a much more positive view about multifamily, as there is not enough inventory, and elevated mortgage rates make owning a new home out of reach for many families. He feels that there will be multifamily opportunities across multiple markets.
We discussed the US$2 trillion “Wall of Maturities” that will need to be refinanced in the next four years (see Exhibit 1). If banks are unwilling to lend, this creates an opportunity for managers who have the capital and expertise. Experienced managers can dictate the valuations and terms.
Exhibit 1: Wall of Maturities
Source: Trepp, fourth quarter 2023.
* Other: Primarily comprised of multifamily lending by Fannie Mae and Freddie Mac. This could also include finance companies (private debt funds, REITs, CLOs, etc.), pension funds, government or other sources.
I asked Rich where he saw the best opportunities. He said “I think opportunity number one is buying troubled assets from banks or from whomever was going to need to sell things over time and inheriting somebody else's problems, but hopefully at the right price. That's an interesting business.” He emphasized “at the right price” throughout our discussion.
Rich and I discussed how advisors should allocate to commercial real estate debt, and the role(s) it can play in client portfolios. Commercial real estate debt has historically delivered strong risk-adjusted returns, an illiquidity premium relative to public market equivalents, low-to-negative correlation to traditional investments, and downside protection (see Exhibit 2).
Exhibit 2: Risk vs. Annualized Return: 10-Year Period
As of March 31, 2024.
Sources: PitchBook, NCREIF, Bloomberg, FTSE, SPDJI, Analysis by Franklin Templeton Institute. Location/Region: US annualized return and standard deviation is over the period of March 2014 to March 2024. Standard deviation is based on one-year rolling returns as of every quarter end. The annualized return and standard deviation are based on net of fees total returns. For US Aggregate Bonds, a fee of 0.43% p.a. is subtracted from the returns. For REITs and US equities, a fee of 0.63% p.a. is subtracted from the returns. The private real estate debt and private real estate equity returns are net of fees. Indexes used: private real estate debt: PitchBook fund search results for US real estate debt funds; private real estate equity: NCREIF Fund Index Open End Diversified Core Equity (ODCE) Index; US aggregate bonds: Bloomberg US Aggregate Index; REITs: FTSE NAREIT All Equity REITs Index, Gross Total Return; US equities: S&P 500 Total Return Index. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. See www.franklintempletondatasources.com for additional data provider information.
Commercial real estate debt has priority in the capital structure hierarchy (“Cap-Stack”), meaning debt holders get paid before mezzanine and equity holders. This is an important consideration given the headwinds for real estate.
For more information check out: https://www.franklintempleton.com/articles/2024/institute/commercial-real-estate-debt-another-way-to-access-real-estate
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WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. Diversification does not guarantee a profit or protect against a loss.
Risks of investing in real estate investments include but are not limited to fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by local, state, national or international economic conditions. Such conditions may be impacted by the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, and environmental laws. Furthermore, investments in real estate are also impacted by market disruptions caused by regional concerns, political upheaval, sovereign debt crises, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Investments in real estate related securities, such as asset-backed or mortgage-backed securities are subject to prepayment and extension risks
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