Before the COVID-19 pandemic disrupted the global economy and brought it to a halt, we entered January 2020 with positive sentiment and unprecedented momentum. All indicators suggested tremendous growth and success, yet no one could have predicted a worldwide virus that would inhibit people from engaging in everyday activity. Contrary to the optimism that people held in the beginning of the new decade, the pandemic brought along a year of agitation, loss, and uncertainty.
Despite the cloud of despair that loomed over the majority of 2020, things are looking up for 2021. With the vaccine’s development and distribution advancing smoothly and the uncertainty of the election resolved, we believe the future for capital markets looks bright. Where’s the evidence? We can provide a few: a positive market outlook with low interest rates, cash heavy banks and investors, and an S&P index that is up 3.8% YTD.
Anticipating a strong year of recovery, we interviewed the most influential CRE experts in the sector to expand and support our predictions. In this article we will share their take on the future of the distressed debt markets.
Continuous Growth In Distressed Commercial Real Estate Loans and Discounted Asset Sales
According to The Fool, 20 large real estate firms had filed for bankruptcy by the end of 2020, including two with more than $50 million in assets. Another report by CoStar Group predicts that in the next five years, there will be more than $126 billion flash sale of distressed commercial real estate, amounting to roughly $321 billion in sales by 2025.
The Federal Reserve also reports that commercial property debt rose to a record of $3.06 trillion for the first time during 3Q of 2020, an increase of close to $800 billion compared to the third quarter of 2012 ($2.2 trillion), which was a 10-year low.
Brock Cannon, Head of National Loan Sales at Newmark, believes that distressed debt created by COVID will permeate further into the future, way past our predicted 5-year growth period. Here’s what he told us: “my team is still working on sales that originated in 2007 and 2008, thirteen years later. We will be working through this distress for at least ten years to come.”
Bid Ask Spread To Decrease
On top of financial instability and uncertainty throughout 2020, distressed deals were confronted with a large bid-ask spread, which is known to be a leading sign of illiquidity in the market. In 2021, however, we anticipate that the spread will decrease due to lenders having more realistic expectations of underpar sales and more available capital.
Chris Skinner, author at TheFinanser.com, speaker, and banking expert, shared with us his opinion on the possibility of bid-ask spread decreasing. He told us, “It’s not just in the CRE space but in all aspects of society. Most people had exposures to loss in 2020 and they will pass those losses onto the banks. Expect a major downturn and increasing NPLs through to 2025.”
Hotel and Retail Fighting To Rebound; Doubtful Office Recovery
According to FitchRatings, hotels and retail delinquencies saw a 33% increase in only one month ($2.0 billion in December 2020 from $1.5 billion in November). Majority of the new delinquencies were from hotel loans ($1.2 billion) and retail loans ($582 million). Moody’s Analytics also shared a delinquency report that supports this trend.
A dissenting opinion, however, was offered by Adam Horowitz, Principal at Lever Capital Partners. “Every time there is a downturn in the market, funds are raised with the anticipation of a flood of NPLS hitting the market,” he says.
Real Capital Analytics shared research which indicates that CMBS had the highest leverage and market share during the 2008 crisis. The scenario is different this time, as we are seeing higher leverage with direct lenders and banks. We must note that CMBS is more concentrated in the hotel and retail areas, and will be reflected in deeper discounts on CMBS distressed sales.
Marco Santarelli, Founder and CEO of Norada Real Estate Investments, directs our attention to the fact that while commercial real estate is struggling, residential real estate remains stable and strong. He says “the brick and mortar retail space has suffered the most, but demand for homes, logistics and storage have increased.”
Possible Office Recovery: Unanimous Uncertainty and Novel Ideas
CBRE predicts that the office sector will be the slowest to recover from the pandemic’s effects. It’s easy to see why so much uncertainty shrouds the sector, as companies have adjusted to digital collaboration tools and have found that, aside from certain complications, most of the work could be done from home. There is a general consensus that evolving trends like remote and flexible working are here to stay.
Others have offered novel solutions that may have hints of potential. New York Times editor, Matthew Haag, proposed that NYC’s real estate could be positively transformed if real estate once reserved for offices were converted to residential spaces. This would work to address the crucial housing shortage problem for NYC residents, who desire to work or already work in the city but cannot afford the high rent costs. While this solution would require many steps and logistical planning like zoning and density rules by the City Council and State Legislature, it is one of many solutions offered by people who attempt to think outside the box.
The report also states that out of Manhattans’ 1 million office workers, only 10% are physically reporting to the office. Additionally, filings to construct new buildings dropped by 22% in 2020, the lowest number since 2010.
The Transformative Power Of AI and Technology That Will Change The Way CRE NPLs Are Sold Forever
As many industries have evolved and adapted to new technology that serves to make transactions and communication more streamlined, some industries find themselves lagging behind and only now begin to realize the necessity of integrating new technology into their toolkit.
“The real estate industry as a whole has been very slow to adopt new technology,” Santarelli states. As the increase in demand to manage CRE deals grows, CRE firms will need broader capabilities of technology platforms to fully meet and satisfy said demands.
In a post-COVID world, the success of lenders, brokers, and CRE firms heavily depends on the capacity of their people to work easily and efficiently in remote work environments. Deloitte reports that most CRE companies were unprepared to meet the demand in this influx of distressed debt.
For all the negative change that the pandemic brought with it, it also acted as a catalyst for positive change. Jim Berry, Vice Chairman and US real estate leader at Deloitte states, “While the pandemic was an eye-opener, we see it as an accelerant of existing trends. It is telling that 56% of CRE respondents to our 2021 CRE Outlook survey said that the pandemic exposed shortcomings in their organizations’ digital capabilities. Only 40% of respondents said their company has a defined digital transformation roadmap.”
Companies that relied on traditional workflows and legacy technology found that they were not able to adapt to the changing environment and demands. The necessity of remote work made one thing clear - digital adoption is not enough. To keep up with demand and operate efficiently in today’s unprecedented climate, digital transformation is necessary for all in the CRE sector.
Technology platforms driven with AI, like Metechi, can help meet this increasing demand. With the help of the platform, CRE firms can increase analytical capabilities and couple them with security and transparency to change the way buyers, traders, and sellers operate in the market. To learn more about how you can buy and sell CRE NPLs at scale, schedule a free demo with Metechi today.