I am currently in California, a place I haven’t visited since just before Covid-19. Recently, reading that some of the planet’s biggest real estate investors such as Blackstone and Brookfield have been handing back keys to lenders, I have been keen to understand the scope of the problems in the US, which will have led to this almost unthinkable of events.
The reverberations of these actions might have consequences for debt pricing across the commercial real estate global markets. Non-recourse debt means just that but, naturally, where your sponsors are of impeccable creditworthiness, what are they saying about the market when they just hand back the keys and won’t even work at curing the problem?
Clearly, in some areas, the problems are so deep that no amount of endeavour is going to cure them, and these super-smart investors would rather prejudice their own credit ratings in the short term than try and resolve the unresolvable.
Santa Monica has, for as long as I remember, been a buzzing, cool place to live with terrific retail stores and a restaurant scene as good as anywhere on the west coast.
But now, with every third store boarded up and ‘to lease’ signs everywhere, the streets are eerily quiet. Ludicrous laws, where there is no bail requirement for thefts under $999, has resulted in a horribly unsafe environment for retailers.
I am a great fan of the US and don’t want to knock it, but this is the economic powerhouse of the world, and these scenes are playing out over many cities and regions. What this means from a societal perspective is worrying, but what does this mean for the US real estate markets and therefore the UK, which relies on positive US sentiment?
There is a sense here in the US that the banks have yet to come to terms with the depth of challenges on their loan books. Refinancing is tough and the usually more bullish bottom feeding private equity investors are few and far between as there is no obvious clearing price yet.
Many landlords appear to be holding tight in the hope that some sort of miraculous recovery is around the corner, but is it possible the worst is still to come?
In the UK, the US opportunity funds are such an important ingredient of our market. We are already experiencing the contagion of sentiment towards offices, which following the global black-swan events is in freefall and no one wants to catch a falling knife. Will this spread to other sectors?
The future look of our built environment is going to radically change. Anyone involved with the built environment must read Thomas Heatherwick’s book Humanise or listen to his fascinating series Building Soul on BBC Radio 4, which brilliantly capture the challenges.
Senior debt is now so very highly sought after and, as in any correction, its providers will look first and foremost to the most vanilla, secure, long-term investments underwritten by the best operational credits.
What happens next is more difficult to predict and the potentially significant global ramifications of the recent abhorrent terrorist attacks in the Middle East are making that job even harder.
Debt is going to become as selective as it will be expensive and equity even more so. Return requirements will remain very high so ultimately values have and will continue to have to bear the pain.
The contagion already affecting the UK debt markets from the US is hurting us even if our demographics and geography are very different because markets are all about sentiment. If my US trip is any barometer of anything, I sense it’s going to get a fair measure worse for the heavily indebted in the wrong sectors than it is now.
Ungeared companies rarely go bust but I suspect even low gearing with the wrong assets could be seriously challenging over the next couple of years.
Not all is lost, though. For those of us who have been through several cycles, the crash of the late 1980s in particular, saw a gargantuan proliferation of space, especially offices, where most commentators predicted the office market would never be the same again.
As markets just do, it worked itself out and while it took many years in real terms to recover, miraculously it did and that was against an evisceration of capital where debt markets were non-existent for a long time.
There is plenty of capital out there today but it’s very greedy and it will want its pound of flesh before it returns to the market, ready to absorb the risks associated with the changes required to initiate the restoration of the next cycle, not just in the US but, with one of the world’s most active investment markets, the UK, too.
Nick Leslau is chairman and chief executive of Prestbury Investments
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