CRE Distressed Investing with Tony Crooks, AEW, Jack Gay, Nuveen, and Reid Liffmann, Angelo Gordon

Stewart: Welcome to another edition of the Podcast. My name’s Stewart Foley, I’ll be your host. Welcome back. Welcome back. Today’s topic is actually a reverse inquiry. Today we’re going to talk about CRE and CRE distressed investing. And the idea for this podcast came from one of our executive council members who had some questions about it, and I reached out to our member community and asked for some volunteers and we have three today.

So I’m very happy to be joined by Tony Crooks of AEW. Tony, welcome. Can you give me your title and the name of your high school and the high school mascot? How about that?

Tony: Sure. Thanks, Stewart. Tony Crooks. I went to Andover High School up in Andover, Massachusetts. They were the Golden Warriors.

Stewart: There you go.

Tony: And I’m a Managing Director at AEW.

Stewart: Good deal. We’re also joined by Jack Gay at Nuveen. Jack, welcome. Same question, can you give your title and high school, and your mascot?

Jack: Hi Stewart. Thanks. Thanks for having me. I am a senior managing director and the global head of the debt business for Nuveen Real Estate. I grew up in Armonk, New York, went to the local public high school, Byram Hills High School, and we were the Bobcats.

Stewart: Nice. All right. I’m going to answer this question. You guys are going to be impressed. And last but certainly not least, we’re joined by Reid Liffmann at Angelo Gordon. Reid, welcome. Same question, just your title, high school, and the name of your mascot.

Reid: Thanks for having me. I’m the head of US real estate at Angelo Gordon. High School outside of Philadelphia, Lower Moreland, and Lion was our mascot.

Stewart: Sweet. I went to Windsor High School, Imperial, Missouri, and we were The Owls. It’s hard to be a tough guy when your mascot is the owls. So, I don’t want to go into who suggested this, but there’s a CIO who said he’d like to get his arms around the CRE space and his first question comes up and says, “There have been some large defaults in CRE recently and expectations are for some more going forward, what’s driving this and how should allocators be thinking about it from a risk management and opportunity perspective?”

So, whoever wants to take off on that. Jack, I’m looking in your direction, so would you kick us off? And then we’ll see if anybody else wants to chime in as well.

Jack: Yeah, absolutely. I think maybe one of the key points of the question is large defaults. And really what we’re seeing is sort of some headline defaults with very large loans defaulting and with the illiquidity that’s existing in the market right now, the larger size of the loan that’s less liquid, but if you look sort of just statistically where we are, we’re certainly way behind default levels that you would’ve seen in the GFC and I think we could all debate and perhaps that’s building, but default levels are far behind what we have seen in the last downturn. I’d say some of it that you’re driving, I mean, clearly, the number one reason is you’ve got rising interest rates and that’s affecting values, and so that with the illiquidity in the market, it’s hard to know where values are and sponsors are trying to decide whether they should invest new money into existing properties with existing capital stacks to sort of protect those investments because it’s hard to pin down value.

And then I’m sure a theme that will hit on is where it’s most prevalent would be in the office market, because there’s on top of the interest rate headwinds that all of the real estate is sort of adjusting to, and not just real estate, but all asset classes are adjusting to this higher rate environment. Office has the added secular challenge of return to work and what office demands will be, and tenants are trying to figure out what kind of commitments they should make to space leasing going forward. So, office has certainly been more of a headwind on the revenue side and the market itself is trying to adjust to these higher rates, and certainly a more uncertain economy.

Stewart: Tony, Reid, anything you want to add on that?

Reid: Yeah, I would echo that. It’s a payment shock we’re dealing with. If you look roughly speaking, rates are up 250 to 350 basis points depending on what asset class. So, office is in a special category with special challenges, we’ll probably talk about it. But that payment shock is reverberating through the entire real estate industry and even in-favor asset classes are going to have to deal with a materially higher cost of financing. A lot of things were done with relatively short-term debt over the past couple of years and so it’s going to take some time for the market to adjust. There’s a significant amount of maturity coming , I think the number is a trillion dollars , over ’23, ’24 combined, so a lot of exposure there. $150, $200 billion of that is office. Again, we’ll talk about that. But cost of debt has moved up and in many cases, revenues aren’t where you need to be to refinance. That’s the big thing we’re seeing.

Stewart: Tony, are you good there or do you want to…

Tony: From our standpoint, office is the black sheep today, but there’s no liquidity right now on the debt side, on capital market side or just not enough to really take care of those maturities outside, even outside of office. And so we’re seeing an environment where most of the debt maturing over the next two years, if the banking system doesn’t right itself quickly, we could be in a severe credit crisis for commercial real estate.

Stewart: And the follow-on question too, from our reverse inquiry, is where in the capital structure do you see opportunity and why? The question is do you see opportunity here and can you talk a little bit about, and we can just go in reverse order, Tony, if you want to take this. The question is specifically senior mes preferred or equity, is there a particular part of the capital structure that you’re focused on or where you think there’s opportunity?

Tony: Yeah, I think there’s going to be opportunities all throughout the capital structure. It’s at these points in the cycle that we normally see the widest opportunity set. We haven’t had much dislocation and stress for the last 10 years, when interest rates don’t have a cost and there’s a bunch of money printing, typically mal-investment happens. And we’ve been building that up for 10 to 12 years, and with the capital market dislocation, we’re going to see opportunity sets across all of commercial real estate and all throughout the capital structure.

Reid: I agree with that. The only other thing, going back to the financing crisis that Tony spoke about, it’s important to note that commercial banks, what’s going on in commercial banks even though there’s a fair amount of specialty finance and non-bank financing in real estate, depending whose numbers you look at, banks account for a lot of the financing. And 60%- 70%, that comes from smaller banks under, $250 billion of assets. Proportionally, a lot more of smaller bank assets are in CRE. If you look at the largest banks, the huge banks, 4% to 5% might be, except for one case where it’s significantly higher, but in a typical regional bank, sub $200 billion bank 20%, 25% of assets may be CRE. Given the deposit pressures that t smaller banks are feeling, that’s another reason in addition to the rising rates that you’re seeing a constriction in financing availability.

Stewart: And kind of following up here, you mentioned office, the question reads, are there specific property types and geographies that you’re concerned about? The property type we’ve identified that you’re concerned about is office. Are there geographies that you’re concerned about some more than others, whoever wants to go? Jack, you were out for a second, so you want to talk about that?

Jack: Yeah, I may just add just on the opportunity set. We would see probably greater opportunities right now in the debt space versus sort of equity or pref equity. And the reason is that the uncertainty in the valuations are being caused by higher debt costs. Partly higher spreads, but partly higher base rates. So the cost of debt has gone up, which if you’re making new loans as a lender, you’re getting paid much better relative value than you’ve seen in a long, long time and really all throughout the capital stack, this will probably lead to overshooting on the downside in terms of property valuations, which may lead to great opportunities or greater opportunities in the equity space eventually. But right now, I would say the opportunity is really more in the debt space, because that pricing has adjusted and equity is still trying to find its footing, if you will, based on this new reality of a higher cost of debt.

Flipping just to the geography piece, I mean look, not all markets are the same. We’ve been alluding a little bit to it on the sector side. Certainly, not all sectors are the same, but some of our cities are more challenged by things like crime and those kinds of things, that social issues that have developed in a post-COVID environment. So they will have the hurdles to overcome in the real estate markets and perhaps on top of the hurdles to overcome in terms of cities and local municipalities getting their hands around crime. So ones where you’ve seen bigger instances of that, and you could throw out maybe it’s a San Francisco or Chicago or Portland, that some of those cities are having more challenges to overcome just around the city itself, on top of the real estate headwinds.

Stewart: And how have the underwriting and terms changed in CRE lending? Can you talk a little bit about that component of it?

Jack: Yeah, sure. The bank surveys are out on a regular basis that talk about constricted lending environments and there’s a lot of preservation of capital, if you will. So if you have less capital to lend, you’re going to lend it on more conservative terms, you’re going to haircut your valuations because there’s more uncertainty around that. So you’re going to lend at lower loan to values, you’re going to have stricter underwriting in terms of where you see valuations on assets and you’re going to be able to get more structure in the deals, whether it be reserves or guarantees or whatever it is that you may be able to structure into the loans.

So it’s really across the board right now, given the lack of liquidity that all the terms that you’re seeing in new loans going out are on a more conservative basis, lower leverage, better protections.

Stewart: And if we’re talking about distress, the last question from our reverse inquiry comes to, what’s the potential size of the problem? Reid or Tony, you want to take a swing at that or…

Tony: I think it’s going to be very large depending on how deep the cycle is. There’s some estimates of over $5 trillion of commercial real estate debt out there and when you look at the capital available on the sidelines, most of the core capital is out of the market today, whether those vehicles have redemption queues or whatnot. And so the capital available outside of foreign capital, the capital available is roughly $200 to $300 billion and that’s a wide range I realize, and it’s a lot of money still, but at the end of the day, it could be just a drop in the bucket for how much capital is needed to restructure the $5 trillion of debt outstanding. And so I think from my perspective, I really think it is a leverage asset class at the end of the day and so until credit growth can expand, we really cannot find a bottom in pricing and values.

And so I have that chart right in front of me, Jack, I keep it right on there. It’s really the percentage of banks tightening credit standards in commercial real estate, and it works almost every single time until that gets back to zero, until they’re expanding credit, loosening terms in credit that the market, the commercial real estate market cannot find the bottom.

Reid: And that’s being shown, the transaction activity is way off. I mean, first quarter ’23 transaction activity was probably down 60% year over year. There is a stalemate, so not a ton’s getting done in equity right now.

Stewart: I’m just going to kind of start with some of the… Kind of dive in here. So Tony, one of your points was, you said when looking at distressed CRE focus should be on identifying broken capital structures, not broken assets. Would you want to elaborate a little bit on that?

Tony: So we are not big believers in buying distressed real estate. Typically, it’s distressed for a reason. You can’t pick up a building and move it to a better corner or a different market and typically the distress real estate requires a large capital investment and the duration to fix that real estate typically is a lot longer than we can underwrite results. And so I think from our standpoint, we’re big believers in buying into real estate through distressed capital structures, and now is the point of the cycle where we’re seeing a significant amount of those. The last 10 years we haven’t seen much distress or dislocation, because of the amount of capital and capital flows to commercial real estate, but I think that the opportunity set for us going forward will be more on distress capital structures.

Stewart: That’s interesting. So, and this is for you, Reid, given the macro backdrop, right, you’re saying that alpha, not beta will likely drive returns going forward. Can you expand on that please and let our audience know how you’re thinking about how to actually make money here?

Reid: Sure. So I just want to say first of all, I agree with Tony that what we call it here, cheap is not a business plan. So there are the potential for a lot of value traps that you want to avoid. The question is how do you make money going forward? If you look over the last 5 to 10 years, sector selection has really played a role. Now if you talk to us, we all probably like the same sectors, but we are coming through a period where if you put a position on even as a market buyer in multi or industrial and just had the position, market fundamentals, capital flows and cap rates, you made a lot of money. And that’s because we’ve been in a secular decline in rates.

If you assume that secular decline is over, how do you make money? The way to make money is you need to be in the right assets, the assets with tailwinds, avoid the ones with headwinds and I think we there’d be broad agreement on what those are. So you don’t really bring anything unique there. So then it’s going to be how can you execute value creation at the asset level? It’s going to be much more of a grind-it-out kind of business where you’re have to execute. It’s not going to be buying in size, putting relatively cheap leverage on, and then the flows of capital just drive your returns. I think that’s different about where we find ourselves today.

Stewart: And so Jack, I’m going to come to you. With the pullback of bank lending, who is lending right now in the CRE market? Can you talk about that? I mean, we’ve talked about illiquidity, there’s got to be some liquidity from someplace.

Jack: Yeah, sure. If you think about where debt capital comes in the real estate markets, there’s really sort of five major sources and the banks is by far the biggest one making up 45% plus of commercial real estate lending. So the banks are contracting and they’re out, public markets are choppy. So CMBS is another 10%, 12% or so of the market and they’re out or certainly less active. There’s debt funds and mortgage rates and that’s another 10%, 11% or so and depending on who they are, they may have liquidity constraints. Open-ended vehicles certainly have more liquidity constraints right now, so they’re slower. But if you look at who still can lend, the insurance companies generally have strong balance sheets. They’re generally unlevered lenders, so they’re just doing senior whole loans and not levering their book.

So they would have healthy allocations still and obviously this audience would be familiar with that, but insurance companies will still, I think get through their allocations this year, which should be similar to previous years. And then the agencies, clearly that is a very big part of lending and it’s targeted towards multi-family, but that’s helping to prop up capital in the multi-family sector, but their allocations are $70+ billion each and they will likely get through their allocations as well. So I’d say the healthiest sources would be the insurance companies and the agencies at this point.

Stewart: Yeah, it’s interesting. I mean, the insurance companies find themselves in a similar situation with just business lending, right? I mean, the banks aren’t lending there either and you’ve seen a lot of direct private credit firms that are looking at the insurance industry, and one of our podcast guests, Phil Titolo at MassMutual said that he thought that insurance companies would be a significant driver of economic growth in the US by being that non-bank lender. So Tony, turning to you, where does AEW see opportunities here?

Tony: Yeah, I think that from our standpoint, and it happens really at certain parts of the cycle, which we think we’re going into, we certainly see core assets repricing and they’ve repriced significantly since last year. And as Reid said, it’s not a beta market anymore. You just can’t buy any industrial building and expect to make your returns. You have to be discerning, you have to really understand location, understand demand drivers in that location much more specifically to that asset class or to that sector than you had in the past. And I think from our standpoint, a repriced core opportunity, where you have individual assets repricing quickly because the sellers need some sort of liquidity for whatever reason, we’ve already started to see that.

And I do think in size, as much as there’s no really debt market in scale today, if you need to sell a large asset today, you are going to have to take a discount. And so for us having larger amounts of capital availability and pools of capital will be beneficial to executing that strategy, just because there is no lending market today and so you most likely will have to buy that asset unlevered and so we’re going to need a sizable discount for that if you’re trying to sell anything in scale.

Stewart: Reid, would you care to comment on where you’re seeing opportunities as well at Angelo Gordon?

Reid: Yeah, I think Tony explained it well. I think this is a part of the cycle where you actually may be able to buy higher quality assets than in the value-add space. If you look at the core market, it is pretty much sidelined and we haven’t talked about it yet, but the big issue in the core market is valuations. A lot of those are open-ended and there’s queues right now to get out. And just to give a sense that if you look at the REIT market, which tends to be forward-leaning, probably down about 25% overall in 2022, I think the year-end NCREIF ODCE, which is a widely used index, was up in 2022, 6% or 7%.

So public markets down 25%, NCREIF up 6% or 7%, I think it’s come down a little bit in early ’23, but the marks have not caught up to reality yet in the core market in the large segment of the open-ended. And they need to generate liquidity. Investors will be reluctant to want to enter until you get those valuations are more in line. So you could see some selling in the core market and they generally on higher quality assets and for that matter, some of the NTRs or non-traded REITs that are out there may need to generate liquidity. They tend to own pretty high quality assets overall, and so that will be an opportunity just to capitalize on illiquidity. You may need, as Tony mentioned, to be willing to buy it with either lower leverage or temporarily no leverage and take that exposure. But I do think that is an opportunity.

Stewart: So just as we wrap here, I’d like to go around and have everybody just… What is the one takeaway that you’d want investors in CRE to take away from this podcast? Jack, I’ll start with you. What do you think the most important takeaway is here today?

Jack: So I think there are opportunities to make new loans in CRE debt. As we talked about earlier, debt pricing has changed dramatically over the last year or so, but both in the base rates as well as in the spreads. So a lot of opportunities in terms of getting paid for that credit exposure. Obviously, a little bit more underlying risk out there in terms of pinning down the values, but you’re getting paid really handsomely for credit risk right now, and this illiquidity premium that exists today, it’s hard to pick exactly when it will end. It go away at some point.

So if you’re a long-term investor and you can lend into today’s market because you have available capital, you’re going to get paid for the credit risk that’s out there, but also this illiquidity premium that you’re able to book today, and eventually that will subside, markets will normalize. But again, very good time to be a lender right now if you’ve got capital at this point.

Stewart: Outstanding. Reid, same question. What’s the takeaway today?

Reid: It should be an interesting time to put money to work. You’re going to need to be nimble as you assess opportunities. How we’ve made money over the last 10 years is not going to work going forward.

Stewart: Really good. That’s terrific. And Tony, how about you?

Tony: Yeah, I would say that the biggest thing is to be patient, right? Don’t rush into anything. Don’t fire sale anything. If you have capital, the fundamentals are not awful in commercial real estate. They may be poor in some sectors, but we see some good long-term secular fundamental demand in demographics that should play well into commercial real estate going forward. Listen, capital markets are pretty bad right now and pretty shut down, but they always recover. They may look differently after the recovery, but I think from a standpoint of, just taking off what Reid said, focus on high quality real estate at a good basis in sectors that we believe will perform better over the long term in terms of demand and demographics, and you’ll be able to produce your returns.

Stewart: I have gotten a tremendous education on CRE from the three of you today, and I really want to thank you very much for being on. We’ve been joined today by Tony Crooks at AEW, Jack Gay at Nuveen and Reid Liffmann at Angelo Gordon. Gentlemen, thanks for being on.

Tony: Thanks, Stewart.

Reid: Thanks, Stewart.

Jack: Thanks very much, Stewart. Enjoyed it.

Stewart: Thanks for listening. If you have ideas for podcasts, please shoot me a note at Please like us and review us on Apple Podcast. We certainly appreciate it. My name’s Stewart Foley, and this is the podcast.

The podcast is available on Apple PodcastsGoogle PodcastsSpotifyPandora — Subscribe today!

Register for Insurance AUM Journal

Register today to confirm your status as an institutional investor and gain access to the latest thought leadership in the industry.

  • Thought leadership delivered to your inbox
  • Confirm your status as an Institutional Investor
  • Complete CFA Continuous Professional Development requirements

By clicking submit you confirm that you qualify as an institutional investor and you consent to allow Insurance AUM to store and process the personal information submitted above.

Lost password