Not all economic downturns are created equal as highlighted in the difference between real estate distressed investing from the Global Financial Crisis (“GFC”, 2010 to 2012) when compared to the COVID-19 pandemic era crisis. This blog post will explore the differences in real estate distressed investing during these two time periods.
Distressed investing in the GFC era focused on firms coming in to rebalance the capital stack. There were cash flowing real estate assets that carried too high of a debt burden relative to income. Well-funded institutional investors were in prime position to bring large amounts of capital into deals and were able to use appropriate levels of debt to reposition properties.
Real Capital Analytics data shows that institutional capital was behind 40% of U.S. distressed purchases between 2010 and 2012. Institutional equity funds were particularly well suited for this type of investing, accounting for just over a quarter of all distressed purchases over the same time frame.
In contrast, the COVID-19 era downturn differs from the GFC in that the pandemic brought demand to a standstill exposing and, in some cases, accelerating pre-pandemic real estate trends especially in retail and hotel assets. As lockdowns remained in place throughout much of the U.S., consumers turned to e-commerce and away from brick-and-mortar shopping which accelerated small business closures and retailers with weaker balance sheets.
The hotel industry also quickly moved to reduce staff and operating expenses, and in some cases shuttered brands entirely, to get through the reduced demand caused by the pandemic. Recently, leisurely demand and remote working have helped drive the uptick in hotel occupancy and rate increases as travelers mix extended vacations with remote work. It remains to be seen on how business and convention travel will come back post pandemic in the age of video conferencing.
With most property owners well-capitalized before the crisis, we believe a way to success in pandemic-era distressed investing is likely through the repositioning of assets that are currently lacking great income prospects, such as the retail and hotel sectors. Preliminary RCA data shows that 12% of distressed assets purchased through the first five months of 2021 were acquired with the intent to redevelop. This is double the proportion of non-distressed sales slated for redevelopment over the same period.
The ground level extensive work required to convert distressed assets to their highest and best use has drawn notice from a different investor pool. Between the second quarter of 2020 and first quarter of 2021, private buyers — predominantly developers, owners, and operators — accounted for 64% of all distressed asset purchases. By contrast, institutional equity funds were behind only 12% of distressed purchases, with the broader institutional capital category taking only 20%. One building conversion opportunity to watch is distressed urban hotels that cater to the business traveler. If business travel demand does not rebound, some hotel operators will likely be forced to give the keys back to their lender. Given the housing affordability crisis that was accelerated with the pandemic, affordable housing investors will likely be eyeing these urban locations for adaptive reuse.
As it stands from Q2 2020 to Q1, 2021 private investors have acquired 64% of all distressed real estate.
Sources: RCA, CoStar.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Assistant Vice President, Asset Management
Boyd Watterson Asset Management, LLC