How One Debt Lender Plans to Play the Second Half

It was a good first half of 2022 for debt borrowers, at least if they were clients of PGIM Real Estate. The real estate debt business of PGIM completed $2.1 billion in core plus and high-yield financing on behalf of investors in its real estate debt strategies for H1. It was a strong performance for the real estate manager, and John Jacobs, managing director, Core Plus Debt at PGIM Real Estate, expects to see more successes in the second half of the year. “We view this environment as an opportunistic time to make good loans, so we continue to look for attractive deals,” he tells GlobeSt.com. 

But H2 is unlikely to resemble the first six months of the year in many respects for PGIM Real Estate’s debt business. Underwriting is changing to account for economic headwinds and the overall transaction volume is expected to decrease as well.

Also, the debt unit is honing its focus on asset types that will have more durable cash flows. “We are being more selective now in asset classes that we will pursue due to concerns about the macro-economic environment,” Jacobs says. These categories include multifamily, industrial and specialty types such as assisted living, life science, self-storage and manufactured housing. 

Assets That Will Thrive 

“These are asset classes that tend to be able to mark their rents more quickly in an inflationary environment,” Jacobs says. “On a more macro level, they have positive demand and supply and economic tailwinds. They will outperform given the secular trends.” 

Of course, the unit was lending in these areas in the first half of the year too. One deal it underwrote, for example, was a $49.8 million floating-rate bridge loan for the acquisition and reposition of a cross-collateralized industrial pool with five properties. 

And now, Jacobs and his team is currently looking at another industrial portfolio but with an eye on making sure the loans can withstand any number of scenarios. This particular portfolio has strong going-in cash flows, is located in strong growth markets and that has institutional capital behind it as well as meaningful hard equity. Plus, a business plan that makes sense despite the economic headwinds.  

Jacobs points out that even if the portfolio were to lose a tenant, the loan should still perform well because there is still enough cash equity and a sponsor with a lot of experience.

There are other changes in PGIM’s real estate debt business approach to market. It is lending at lower leverage levels from H1 over concerns about property valuations in the rising interest rate environment. What that lower leverage is depends on the deal, asset class and market but in general borrowers can count on 5 to 10 leverage points lower than the first half of the year. 

There are also fewer deals available as buyers and sellers decide not to transact. “Sellers are recognizing that the market has changed and while some are willing to sell, those that are not forced to sell are more inclined to wait it out. They are not willing to take the price reduction that buyers are wanting” which in some cases has been 10% or more.

Waiting for Distress (Again)

These trends are happening across the board with most debt lenders but as of yet this capital market disruption hasn’t trickled down to create underlying property-level disruption, Jacobs says. It is something he is carefully watching for but as of now he is still seeing income growth. 

When it does happen, he suspects it will be in the six-to-12-month range. “We still have pent up demand for some of these asset classes. We have to see a bigger pull back in economic activity before it will trickle down to the asset class.” 

The commercial real estate industry was on notice for distress before, during the beginning of the pandemic. This time is different, starting with what had been a very accommodative Federal Reserve and lenders that were willing to work with borrowers. 

This time, “my expectation is that lenders will be accommodative where they have to be,” Jacobs says. “The obvious big difference now is the Fed is taking out liquidity as opposed to putting it in.”