PIMCO’s Murray: It ‘isn’t about value-adding anymore’

With the private real estate sector experiencing significant credit shortfalls, managers should prioritize their financing relationships over adding value to their property portfolios, delegates at the PERE Network America Forum were told last week.

In his keynote address, John Murray, managing director, global private real estate, at asset management behemoth PIMCO’s private commercial real estate business, told the members a “massive capital dislocation in US commercial real estate” is challenging where managers should be concentrating their efforts.

In particular, with lenders currently cautious when it comes to issuing new debt, these relationships will need special attention.

He said: “The decision isn’t about value-adding anymore. The reality is a lot of us got flushed out in terms of the value of assets.

“Now it is about managing relationships with long-term lenders.”

Further, for these to be prioritized, Murray said team compositions could need altering. “When you think about your teams, that’s a different kind of capacity you have to think about in terms of making decisions.”

Since the end of 2022, interest rates have risen swiftly by 500 basis points causing the cost of real estate finance to soar and, simultaneously, make fixed-income assets more attractive for capital providers. Consequently, valuations in real estate have come under significant pressure and this has stilted both capital formation and capital deployment in the sector.

According to PERE data, $92.8 billion was raised for private real estate in the first three quarters of the year, notably less than the $150.4 billion raised for the same period in 2022, putting the year on course to be the worst private real estate fundraising year in more than a decade. Meanwhile, CBRE is forecasting a year-on-year reduction of 34 percent in terms of global property investment volumes in 2023. The broker recorded $1.14 trillion of investment in 2022.

By Murray’s reckoning, the severity of capital market dislocation with the real estate sector means value-add strategies for assets acquired before the spike in base rates are less likely to be commercially accretive now. Therefore, he said these should be deprioritized when compared with the effort firms put into capital partner relationships.

“I’m not saying value-add decisions were easy,” Murray said. “But those were secondary to what we’re experiencing today.”

He said most banks, traditionally the largest source of finance for commercial real estate borrowers, were prioritizing their long-term relationships when it comes to approving new loan originations. “Every deal needs to go through a relationship committee today.”

Murray listed the sector’s own priorities when it comes to real estate exposures: “Banks are focused on minimizing losses, reducing exposure and [their] regulatory capital. Extending loans is still the preferred method – and there’s a lot of art that can go into that,” he said, adding that loan sales, including mixed pools of performing and sub- or non-performing debt, and also structured transactions should follow in time with foreclosures likely to be a final resort for most.

In the meantime, private real estate managers are likely to suffer more than other kinds of real estate organizations, given their traditional focus on placing equity into deals, much of which will have been wiped out as rates spiked.

“Think about a typical value-add or opportunistic strategy. It was a short-term business plan: build the asset, lease it, sell it – these are three-year floater types of deals. That’s where the pain is going to be felt,” said Murray.

He singled out private funds raised during 2013 and 2014 as vintages he expected to experience a “double whammy” of loans maturing and limited available equity and no more time to rectify the business plans of their investments. “They’re at the end of their fund life, which can lead to some uneconomical decisions.”

Murray added many debt funds and mortgage REITs originating loans before the spike would also “no longer be able to protect their positions.” He said the news was relatively brighter for the country’s REITs, however, which are generally geared at about 20 percent loan-to-value – even if they too would struggle to raise new equity.

“The good news is for those with capital, it is a tremendously exciting time,” he added. In line with PIMCO’s Real Estate Reckoning report, which he referenced in his address, he said the firm’s current investing preference was via newly issued real estate debt. “Then it is rescue capital. Equity is really a 2025 and beyond opportunity. It’s going to take time for those nasty, hairy deals to play through restructuring.”