The chart below highlights we are likely bottoming out in commercial real estate valuations.
As central banks begin cutting rates, the effects of 2024’s high-rate environment are still unfolding, particularly in real asset prices. While monetary easing should plot a path to real asset values recovering as long-term yields improve, history indicates that a period of adjustment comes first. This period brings both challenges and opportunities for equity investors and private credit lenders.
- Asset prices may be nearing a bottom but transactions over the next few months will crystalise eroded equity positions for some borrowers. Transactions that have been delayed closing for a range of reasons are picking up, indicating a potential market bottom as these prices filter through.
- We see further adjustments in valuations as likely before there’s a true rebound. Assets without income generation, for example, land subdivision or vacant b-grade offices, will see the largest price corrections, some off 35-45% from valuations set in the low-rate environment of 2021/22.
- With a tight credit environment and refinancing becoming more difficult, the quality of sponsors seeking private credit is significantly improving. We’re seeing ultra-high-net-worth borrowers and institutional investors increasingly turning to private credit to manage new opportunities. With many assets still holding value in this market based on specific location and demand, we’re seeing strong opportunities for lending against attractive collateral.
- Recycling capital remains crucial in this market. We are actively redeploying funds from challenged assets and borrowers into stronger opportunities, even if it means continuing with the path to transact assets at a time borrowers would rather we ‘extend and pretend’.
- Ongoing independent valuations of the collateral underpinning our loans demonstrate a good equity buffer, however, as we force one or two challenged borrowers to sell in the coming months we will test the depth of market liquidity.
As real asset prices bottom out and reset, we expect to experience the double-edged sword of the bottom of the cycle. The current environment is generating a vintage of higher quality borrowers, that several years ago would not have engaged higher cost non-bank funding. Conversely, we may see several properties sell at prices well below valuation expectations. On balance, we think the best course of action is to recycle capital into better risk-adjusted opportunities, even if one or two asset sales precipitate the possibility of a modest impairment to recovering all capitalised interest.
