Dry Powder Waiting to Jump into CRE Market

Significant concerns and discussions surround the upcoming amount of commercial real estate (CRE) debt that will be due in the coming months and years. Nearly $400 billion in commercial property loans are set to mature in 2023, according to data from MSCI. That will be followed by nearly $500 billion CRE debt due in 2024, with more than $400 billion CRE debt due in 2025, 2026, and 2027, respectively.

Perhaps the biggest anxieties about these debts stem from the fact that CRE loans are maturing in a market that has seen rising borrowing costs, a drop in sales and valuations, and tighter lending restrictions over the past year. For multifamily assets, the price per square foot shifted from $794 per square foot in the Second Quarter 2022 to $784 per square foot in the Second Quarter 2023, according to data from Avison Young. For retail, the price per square foot was $1,255 in the Second Quarter 2022 and dipped to $1,173 in the Second Quarter 2023. Office fell from $1,063 per square foot in the Second Quarter 2022 to $588 per square foot in the Second Quarter 2023, while land rose from $390 per square foot in the Second Quarter 2022 to $541 per square foot in the Second Quarter 2023. As pricing has shifted downward, it could be challenging for some borrowers to refinance, given that loan to values have been severely altered.

The inverse effect of these trends is that the ‘dry powder’ which has been held while investors wait for meaningful pricing corrections could now come into play. Since the pandemic, many potential buyers have opted to sit on the sidelines and not move forward on acquisitions. There is now a supply of equity that could be used to take on distressed loans and properties put on the market. The market could expect to see dry powder from funds and other sources such as foreign investors being used in the coming months, which may provide some relief for CRE loans that are maturing in a shifting market.

Regional Banks Hesitant to Lend

Smaller banks, reeling from setbacks including the closure by regulators of Silicon Valley Bank, Signature Bank, and Silvergate Bank in March 2023, are shifting away from CRE debt. During the Second Quarter2023 regional banks accounted for just 25% of new CRE loans worth $2.5 million or more, which was a 900-basis-point drop from the First Quarter2023, according to MSCI. The dip represents the largest quarterly decline in market share for regional banks since 2011, when MSCI began tracking the data.   

With rising interest rates and the potential for regulatory increases related to capital reserve requirements, it is likely that regional banks will continue to be hesitant in their decisions for CRE loans. Given this, borrowers may need to look for other options when their loans come due. Owners may consider getting their financing from a different source, bringing more equity to the table, or selling distressed properties.

Not all Asset Classes Perform the Same   

As we survey the economic fluctuations and lending patterns, it’s important to remember that it isn’t necessary to paint the entire real estate market with a single brush. In some cases, investors have been turning away from office properties and opting instead for multifamily and industrial. Today, multifamily has the highest percentage of sector-specific dry powder allocated toward it compared to the other asset classes, followed by industrial.  

From 2013 to present-day, offices accounted for 60.6% of total investment activity; during the past year, offices made up 39.3% of total investment activity. Today, office funds account for just 2.0% of sector-specific dry powder. (AVANT and RCA were used to analyze historical investment activity and CoStar was used for the uncommitted capital analysis).

Drawing further on these data sources, multifamily funds accounted for 5.6% of total investment activity from 2013 to present-day. During the past year, multifamily made up 8.4% of total investment activity. Today, multifamily funds account for 57.7% of sector-specific dry powder. Industrial funds represented 25.2% of total investment activity from 2013 to present-day. During the past year, industrial funds accounted for 41.0% of total investment activity. Today, industrial funds represent 25.9% of sector-specific dry powder. Retail spaces represented 0.1% of the total investment activity from 2013 to present-day. In the past year, retail made up 0.3% of total investment activity. Today, retail holds 1.6% share of sector-specific dry powder.

Increase in Dry Powder During Past Years

The dry powder for funds focusing on U.S. investments totaled $15.8 billion in 2020, per data from Prequin. Now, three years later, that figure has increased nearly three times to reach $45.2 billion. The amount of capital getting stockpiled correlates with investors who have been choosing to sit on the sidelines. Blackstone has a global real estate fund, Blackstone Real Estate Partners X, with $30.4 billion, which includes $29 billion in dry powder, per Prequin data.

Overall, Prequin estimates there is more than $205 billion waiting to invest in CRE within the U.S. The ample amount of dry powder begs the question, “What happens when these major investors decide to jump in?” While clearly a large amount of debt is coming due, it doesn’t have to completely replaced by lenders. Some of it could be offset by fresh capital that is ready to come to the table.  

Foreign Investors Interested in the U.S.

Investors from places outside of the U.S., who often bring higher levels of equity to the table, have carried out more transactions in recent times. During the First Quarter 2023, foreign investment in the U.S. real estate market reached its highest point since 2015 and accounted for 18% of the total sales dollar volume, according to the Avison Young State of the Market report for the Second Quarter of 2023. New York City holds the top spot for investors from other countries. Foreign investment in New York City more than doubled in the First Quarter of 2023 compared to 2022. Buyers from Korea have been the most active in New York City, followed by buyers from Germany, Japan, and Canada.

Looking to the future, we can expect to see shifts as CRE loans come due and lenders continue to tighten the borrowing requirements. For funds that have been gathering dry powder, along with other players and investors, this could bring opportunities. These sources could provide the equity that lenders are seeking, and in doing so, help alleviate the distressed loan market. Essentially, putting the stockpiled dry powder into use could serve as a great neutralizer to the challenges ahead.