It is sad to see all those fresh-faced and eager “distressed asset managers” marching forth with cash-stuffed backpacks through the cheering throngs of pension sponsors, sovereign wealth funds and family office staff. Those who have seen more than one cycle know many of them will not survive.
Or at least the money they’re armed with will be lost on the bloody fields of bankruptcy courts, unfixable operating companies and deserted properties. That is usually what happens to inexperienced “deep value” managers when they are given can’t-miss opportunities at the beginning of the down cycle. The cheap assets and arbitrages they initially discover turn into life-sucking disasters.
The first wave of distressed asset purchases, will, I believe, be particularly bad when it comes to commercial properties, including the trophy buildings and the securities supposedly backed by their future rents. Even in post-2008 America, commercial property, commercial mortgage-backed securities and property-related collateralised loan obligations eventually righted themselves.
The US investment disaster in the last crisis was concentrated in residential properties, particularly among the more hopeful end of single-family properties. Thanks to the post crisis regulatory response to the housing crash, the US has not been building enough houses in recent years. That has hurt productivity by crushing the nation’s competitive advantage from having a mobile workforce.
But hey, housing finance today is in relatively good shape, thanks in part to the government sponsored entities and their de-risking of the middle class market. And compliance people have done well.
Now, as commercial properties such as malls and office buildings are gradually repopulated, or not, as coronavirus shutdowns are lifted, we will find the initial evidence of lost rents and downgraded securities.
But this will not be the momentary stumble followed by a V-shaped recovery of administration and deal-sponsor lore. Investors will find this more like being in a wheelchair pushed down a very long flight of stairs.
You would not necessarily know this by looking at the commercial real estate related share prices. The iShares CMBS ETF is trading in the green for the year to date at a bit more than $55, having recovered nicely from its March low of $49. BPY, the Brookfield complex’s property-centric vehicle, is trading near $11, well off its post-coronavirus low of $7.10.
And in the bond markets, the AAA tranches of commercial property CLOs and CMBS bonds are trading way up, first on the reassurance of a Federal Reserve rescue bid, and then on the sheer cheapness of repo financing and renewed yield desperation. Also, even the laziest buy side investors finally read the documentation for the AAA tranches they had bought and collectively realised that even in a depressed, default strewn economy, they were likely to get most of their money back.
Because they can claim priority over the AA, A, BBB, B, CCC and all the grades in between, they can screw the other tranches out of whatever cash the underlying buildings could generate. Legally correct, with lots of precedent and disclosure.
The optimistic outcome being peddled by property promoters is that they can see through the temporary problems such as plague, depression and rage-fuelled politics. They are, they say, patient investors, with your money, that is.
And that might work, but there is too much debt to service here. Property managers can defer some rents, finance some extensions, and dress up balance sheets for one last orgy of equity raises.
That might get them through the end of this year, but not longer. And unfortunately, any profits from their in-house distressed financing or turnround arms will be eaten up by the losses on most of their book.
Then they will have to face the problem that while the AAA holders might have survived, the more speculative tranche holders will be wiped out.
“The optics of (official) rescues for CLOs and CMBSs are bad. Without the ‘support bonds’ (ie the BBB tranches on down to CCCs), there can be no AAAs,” says Ralph Delguidice of Montreal’s Pavilion Global Markets. “Then there is no bid for the underlying properties. Only in a world where securitisation allows you to pretend one plus one equals three can private equity firms and banks sell this stuff.”
The prospective unwinding of the securitisation model is an existential threat for the promoters, the investors, and everyone else who has made a living off the US commercial property trade.
