After a year of falling transaction volumes and valuations, higher interest rates with no certainty of reductions, and difficulty in getting refinancing, there have been concerns about the state of CRE credit markets.
Goldman Sachs looked at some trends from the last few quarters of activity and analyzed the results.
Overall, it found that debt capital remains available for borrowers that can withstand more restrictive and costlier financing options. Refinancing needs have also been partially addressed via loan modifications – a trend Goldman Sachs thinks will persist. From a credit performance standpoint, the share of loans behind on their debt service payments or being worked out by lenders has increased, it also noted, but added that this increase is yet to translate into higher losses on loan portfolios, keeping systemic concerns in check.
From their viewpoint, things have become stickier in credit. It would be odd if knowledgeable people claimed they hadn’t. But they still haven’t transformed into something industry-wide presenting immediate systemic danger.
Not that every asset class has been strong, but valuations have “somewhat normalized” across public REIT equities, senior unsecured REIT bonds, and CMBS. Single-asset/single-borrower CMBS, bond performance has remained strong, outside of office.
Again, aside from office properties, “property operating performance has generally remained resilient, though dispersion across and within property types has been elevated.” Goldman estimates that “newer and higher-quality properties will likely continue to outperform older properties” except for multifamily. “And while some regional supply overhang will keep weighing on near-term net operating income, the historically low level of construction starts bodes well for longer-term rent growth in apartment and industrial properties.”
To understand the analysis, it is important to recognize that Goldman is looking at a path forward, not current conditions. They considered debt financing, loan portfolio credit performance, property operational performance, and cross-asset performance in public equity and fixed-income markets. They came to four conclusions:
There is still resilient credit availability, “suggesting the risk of a credit crunch is still remote and leaving us comfortable with our view that the likelihood of a systemic shock from the CRE market is low.” If something were to go wrong, the signs would have already begun to appear.
Extensions and modifications will remain the main way borrowers will address their difficulties in refinancing. Although not a guarantee, lenders are likely to work with them because no one wants repossessed properties on their balance sheets.
Debt financing resilience will stabilize property performance, “especially outside the office sector.”
Finally, “the magnitude and speed of erosion in the risk premium provided by the new issue CMBS market has shifted the opportunity set to bond selection in older vintages in the secondary market.” Goldman prefers single-asset/single-borrower bonds backed by retail and luxury resort properties.