In the early 1990s, during the savings and loan crisis, the late real estate investment pioneer Sam Zell coined the phrase “stay alive till ‘95” in expectation of a V-shaped recovery in property values for asset owners that could weather the storm.
In a soon-to-be-published whitepaper, New York-based private markets investment and advisory firm StepStone Group references both past and present downturns, arguing “stay alive till ‘25” is the new market mantra.
“The important thing that I’ve learned in my career is that property values can drop, even precipitously, but they always come back as the cycle corrects, and at values that are higher than their pre-peak levels,” said Jeff Giller, partner and head of StepStone Real Estate.
“The trick is to be able to hold your assets through these tough times, not give them back to the bank, so that you can live to fight another day. ‘Stay alive till ‘25’ means you can benefit from the recovery and enjoy that value accretion on the backside of the downturn.”
In today’s market, this thinking applies mostly to assets that are in valuation distress as opposed to operational distress, he added. Some assets, particularly offices, may not recover from the immense structural changes taking place in the sector post-pandemic, but for assets that are operationally sound and impacted solely by the high cost of interest and over-leverage, managers need be able to restructure their balance sheets.
In the whitepaper, titled Bull Market for Real Estate Secondaries, the firm posits that recapitalizations and other forms of manager-led secondaries will be an important way for real estate managers to meet funding gaps at loan maturity, enabling them to hold assets long enough for values to recover.
In this higher interest rate environment, sponsors will be under pressure when debt matures to find equity to fund the gap between their refinancing proceeds and the amount required to pay off the loan. Other conditions that may trigger the need for a recapitalization are when borrowers breach their debt covenants, or need additional capital to counterbalance costly purchases of interest rate caps.
More stress
Giller told PERE that, at this point in the cycle, the GP-led market has yet to reach the volume he expected. But with a substantial wall of debt maturing through 2026 – over $2 trillion in the US alone per the whitepaper – borrowers and lenders will soon need to figure out a permanent solution. “We’re seeing this intrinsic build-up of maturity breaches in debt that need to be solved – it’s going to take some time, but it’s there.”
Indeed, Giller said the firm’s deal pipeline is up 40 percent year-on-year, as more borrowers come under stress and look for liquidity. However, he added, only a relatively small proportion of those deals are actionable. “We feel the bid-ask gap – the difference between what the lender will accept as a payoff and what the borrower will pay – is still pretty wide. There’s also a bid-ask gap between what the GP will settle for from its sources of recapitalization proceeds, and what groups like ours will pay given the risks in the market.”
Traditionally, around half of StepStone’s deals are in the US, and about half are in Europe. Giller pointed out that Europe, especially the UK, has been quicker to mark down values, meaning the market there is more actionable at present. “We have a substantial pipeline in Europe and we’re working on closing deals in the region right now. The US has been slower to mark to market, and so while our pipeline has gotten bigger, it’s a bit smaller than in Europe.”
Giller thinks that once there are enough maturing debt situations, and once the bid-ask gap narrows, there will be substantial GP-led transaction volume in both regions.
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