CRE Investors May Have Missed the Window for Distress

In the last downturn, some CRE investors were able to scoop up distressed assets by this point in the cycle. But so far, those conditions haven’t materialized in the Covid-19 crisis, according to Real Capital Analytics.

The Global Financial Crisis started in December 2007. In Q1 2008, commercial property price growth turned negative when the RCA CPPI US National All-Property Index dropped 2.6% year-over-year. 

In early 2007, distressed sales totaled less than 0.5% of commercial real estate transactions. In Q1 2008, they inched up to just under 1%. By the end of 2010, distressed sales were 20% of the total sales market, according to RCA.

Fast forward to today:  three quarters into the COVID crisis, distressed sales again account for 1% of transactions. RCA notes that the three-month mark was when the price declines in the GFC began.

That’s where this current COVID crisis seems to differ so far. While the pace of price increases has slowed, it is still growing, with the All-Property Index showing a 5.7% year-over-year gain. RCA expects the Q4 2020 RCA CPPI figures, which will be released shortly, will not show the start of the same sort of price declines as at the beginning of the last downturn.

It may be that potential buyers of distress have missed their window. With the vaccines being rolled out, there is an end in sight to the COVID crisis. Given what seems like a temporary situation, it’s hard to see owners or banks taking a loss on their assets. Instead, RCA says they’ll continue to paper over problems.

But some investors will not be able to hold on, even with the temporary nature of the crisis. In Q3, outstanding and potential distress arising in 2020 totaled around $130 billion, according to RCA.

“As these distressed loans move through the system, some are going to end up in workouts and foreclosure,” according to RCA’s Jm Costello. “The open question is whether there will be enough of these deals to lift that distress portion of total sales to a level that changes investor expectations on pricing overall.”

Other groups are predicting that distress will materialize over time as it did during the GFC.

CoStar Group expects a large scale of distressed sales to hit mid-2021 and pass the number of those transactions in the GFC. The company modeled 16 different scenarios to determine how bad the carnage would be from this recession. In those exercises, the amount of distress landed between $92 billion to $370 billion, though it will likely be $126 billion.

“It’s a pretty wide range,” says Xiaojing Li, managing director at CoStar Group. “We think it [the amount of distress] could be a blended scenario that is somewhere in the middle.”