The distressed US real estate market currently presents what Bloomberg describes as one of the best opportunities in a generation. As the commercial real estate (CRE) sector grapples with a severe downturn, investors with the right expertise and strategies, and well-informed financial advisors, stand poised to benefit. To best navigate and take advantage of this opportunity, financial advisors must take care to invest with managers who have proven track records and specialized knowledge.
Distressed investing involves acquiring assets or companies that are experiencing some form of distress at a significant discount under the premise that their value will increase once the distress is resolved. Sectors currently ripe with opportunities for distressed investing include financial services (especially those involved with digital assets), automotive, healthcare, and, particularly, real estate.
The commercial real estate sector is experiencing a crisis, with a huge proportion of commercial buildings sitting nearly empty in towns and cities, due to Covid-19 and increased remote working. Commercial property owners are struggling to maintain buildings, weighed down by the cost of capital tied up in their inventory and unable to collect rent, with fewer occupants. Last year, delinquent loans tied to commercial properties rose to $24.3 billion from the $11.2 billion registered in 2022. According to MSCI, more than $38 billion of U.S. office buildings are now threatened by defaults, foreclosures or other forms of distress—the highest amount since the fourth quarter of 2012. This has even impacted the U.S. banking industry: second quarterly bank earnings revealed that major banks like Wells Fargo and JP Morgan were facing mounting office property distress.
This rising market stress creates a compelling opportunity for distressed investing. This has been recognized by private investors, and there is a significant amount of private money set aside for property investment. According to Preqin, about 64% of the $400 billion of dry powder allocated for property investment is targeted at North America, the highest share in two decades. Many of the commercial buildings sitting empty will be turned into residential or mixed-use buildings, and distressed investors can capitalize on this.
Financial advisors should be careful to invest with managers who have performed well during numerous economic cycles and have the required expertise. Distressed investing can be lucrative, but it can also be risky. Returns are heavily dependent on the skill of the manager and can vary wildly. The situations distressed investors are involved in are also complex, and so managers must possess highly specialized skills and knowledge in bankruptcy law and proceedings, corporate restructuring, negotiation tactics, and capital structure. An optimal method for advisors to capitalize on the opportunity in distressed real estate, while managing risk, is through a portfolio approach, as opposed to solely investing in one distressed fund. By not putting all their eggs in one basket, advisors can diversify allocations and minimize portfolio risk.
In every market upheaval lies the potential for remarkable opportunity, and the current state of U.S. commercial real estate is a testament to that. While the complexities are undeniable, so too are the rewards for those who approach the situation with insight and precision. By partnering with expert managers and thoroughly understanding the evolving dynamics, financial advisors can position themselves - and their clients - to capitalize on this investment prospect. The window is open, but it won't remain so indefinitely; now is the time to act decisively and thoughtfully to seize what could be the investment opportunity of a lifetime.
1 Callanan, Neil. Bloomberg, Distressed Property Buyers Seek Out ‘Exceptional Bargains. Jul. 10, 2024.
https://www.bloomberg.com/news/articles/2024-07-10/us-commercial-property-crash-is-set-to-deepen-the-pain-elsewhere
2 Barnes, Samantha. International Banker. Commercial Real Estate Loans: A Ticking Time Bomb for US Banks. May. 28, 2024.
https://internationalbanker.com/banking/commercial-real-estate-loans-a-ticking-time-bomb-for-us-banks/
3 Barnes, Samantha. International Banker. Commercial Real Estate Loans: A Ticking Time Bomb for US Banks. May. 28, 2024.
https://internationalbanker.com/banking/commercial-real-estate-loans-a-ticking-time-bomb-for-us-banks/
4 Heschmeyer, Mark. CoStar, Two Major US Banks Forced To Deal With Mounting Office Property Distress. Jul. 12, 2024.
https://www.costar.com/article/31022204/two-major-us-banks-forced-to-deal-with-mounting-office-property-distress
5 Callanan, Neil. Bloomberg, Distressed Property Buyers Seek Out ‘Exceptional Bargains. Jul. 10, 2024.
https://www.bloomberg.com/news/articles/2024-07-10/us-commercial-property-crash-is-set-to-deepen-the-pain-elsewhere
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