Rethinking CRE Risk & Reward in 2024
Commercial Property Executive - By David Frosh, Fidelity Bancorp Funding CEO, January 17, 2024
https://www.commercialsearch.com/news/rethinking-cre-risk-return-in-2024/
It's not economic cycles that determine your level of opportunity, writes David Frosh of Fidelity Bancorp Funding.
Throughout 2023, economists and stock market analysts found themselves notably off the mark in their predictions, surpassing even their usual dismal results. Contrary to expectations, economic growth has exceeded the vast majority of projections. Amazingly a significant uptick in interest rates was met by continued growth in national housing prices. No one predicted this.
To grasp the significance of the current economic landscape, reflect on the fact that a person needs to be approximately 36 years old to have navigated through a prolonged recession as an adult. From 1981 to 2021, interest rates plummeted by a staggering 2,000 basis points and markets for both debt and equity soared all over the world (the S&P 500 increased approximately 10x during this period). Despite numerous forecasts of an impending downturn in the face of higher interest rates, the economy has remained robust. The question now looms: where are interest rates headed? The answer seems elusive, leaving even seasoned analysts without a clear trajectory. My bet is that analysts will continue to be wrong. More importantly it should not matter to investors.
Industry stalwarts such as Howard Marks, Warren Buffet, Charlie Munger, and Ray Dalio have consistently cautioned against succumbing to the noise of market speculation. While their advice holds merit, the collective response has been to ignore them. From the cryptocurrency sphere to the stock market, individuals have embraced significant risks without penalty. Marks astutely points out that over the past decade, those who meticulously researched and pondered risk did not fare as well as those who did less homework and spent more time on the golf course. The absence of penalties for high-risk ventures created an environment that enabled investors to amass unprecedented wealth. The continuous decline in interest rates masked many errors while amplifying gains for average investments.
Despite interest rates still lingering below the 50-year norm, predicting their future movement remains an enigma. Warren Buffet asserts that the golden age for investing may be a thing of the past, ushering in an era where investors must once again hone their skills. Investors need to focus on the opportunities the market is presenting rather than what might happen.
Howard Marks suggests a closer examination of bonds and private credit. With over $1.5 trillion in commercial real estate loans coming due over the next three years, which will need to be refinanced or paid off through property sales, a remarkable opportunity exists. Banks, facing challenges not entirely of their making, are being replaced by alternative lenders because regulatory constraints make it difficult to lend. No bank wants to be the next Silicon Valley Bank.
For the first time in a generation, bonds may offer returns comparable to the stock market but with lower volatility and arguably lower risk. Private credit funds, such as our own Fidelity Bridge Loans, provide investors with opportunities to capitalize on the current environment. Our investors are achieving 8.5% returns on asset backed loans at moderate to low loan-to-values (up to 9.5% on a tax-equivalent basis for taxable investors given REIT tax advantages).”
While it remains uncertain whether this will be the golden age for debt, skilled investors in bonds, equities, private equity, venture funds, and real estate will once again set themselves apart. Instead of fixating on interest rates, the emphasis should be on excelling in one's chosen domain. Risk and reward must once again form an integral part of the investment thesis, not solely focused on returns.
