The opportunity is distress – without the big discounts

Back in August, Ralph Rosenberg spoke with PERE about real estate distress emerging not only from the much-maligned office sector but also the most in-demand property types. At the time, the global head of real estate at New York-based mega-manager KKR noted how borrowers in even the most robust property sectors had less available financing, were putting more equity into refinancings because of the surge in borrowing costs, and would need to sell properties to create liquidity because of limited access to capital.

The confluence of these factors would lead to distressed opportunities in many sought-after sectors with sustainable demand drivers, such as self-storage, multifamily and data centers, Rosenberg predicted. Those opportunities would result from “very healthy properties” caught up in “this massive deleveraging cycle,” he said.

Fast forward eight months, and distressed opportunities have yet to emerge on a large scale, according to Rosenberg’s colleague, KKR’s head of commercial real estate acquisitions Roger Morales, speaking on this week’s episode of broker CBRE’s The Weekly Take podcast. That said, he pointed out the firm has focused on equity investors facing redemption pressure, such as managers of open-ended funds and non-traded real estate investment trusts, for much of its deal flow.

Owners facing liquidity issues and under pressure to sell is one key component of real estate distress. However, the types of properties KKR is acquiring do not meet the traditional definition of distressed assets in one important respect: pricing.

As Morales pointed out, KKR’s strategy is “to buy high-quality assets at fair prices,” both for its opportunistic funds and lower-return vehicles.

The firm’s expected returns remain unchanged, however, based on the assumption that the higher quality but lower execution risk of these assets is expected to offset the lower cash yields from more elevated asset prices and debt costs.

This focus on buying quality involves not only targeting in-demand sectors such as self-storage and industrial but also sticking to the primary markets that attract many bidders. Although global commercial real estate transaction activity in 2024 fell to its lowest level in more than a decade, per JLL data, high-quality properties remain liquid. Most of today’s active investors are not chasing big discounts – as evidenced by the lack of liquidity in lower-quality assets in secondary and tertiary markets, where significant markdowns are readily available. Instead, they have shown a willingness to pay higher prices for more liquid properties.

Morgan Stanley Real Estate Investing is one such firm, as demonstrated in PERE’s April cover story, which goes live next week. The real estate arm of the New York-based investment bank has been pursuing opportunities in multifamily, which accounted for the largest portion of potentially distressed assets among US commercial real estate sectors at the end of 2023, according to data provider MSCI.

Lauren Hochfelder, co-chief executive of MSREI – which has both core-plus and opportunistic strategies – told PERE that investing in the sector at present is not about getting a bargain. Indeed, she preferred to take a lesser discount on an asset that she wanted to own rather than a larger one on a property that lacked “the right demand tailwinds going forward.”

Today’s buying opportunity amid a credit market dislocation is therefore acquiring prime assets that otherwise would not likely be available. Despite rising distress, for some of private real estate’s biggest managers, buying cheap is not the aim, because a low price is not a guarantee for a well-performing investment.