$500bn opportunity for commercial real estate private debt

There is a $500bn (£394bn) opportunity in the commercial real estate debt market as banks retrench from lending, according to KKR analysis.

This funding gap will be filled by commercial mortgage-backed securities (CMBS) and debt funds, the investment firm said.

Regional bank failures in the US, combined with a decline in property values, banks’ liquidity and commercial real estate portfolios – specifically office exposure – have raised concerns among regulators and caused banks to pull back from lending to the sector.

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“Doing some back-of-the-envelope math, if bank lending recedes to 40 per cent of the roughly $5.8tn commercial real estate debt market from 50 per cent, it leaves a gap of over $500bn,” said Matt Salem, head of real estate credit and partner at KKR, in an analysis on the firm’s website.

“Who will be able to fill that gap? We do not think insurance companies or U.S. government agencies can allocate significantly more to commercial real estate given their existing exposure. That leaves CMBS and debt funds.”

KKR expects CMBS issuance to increase to $62bn this year from $47bn last year, and for this growth trend to continue over the next several years.

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It also noted that private debt funds are sitting on $39bn in “dry powder”, meaning undeployed capital.

“These are large numbers, but taken together, current non-bank financing remains insufficient to fill the void left behind by the pullback from banks,” Salem added.

KKR is forecasting higher deal activity this year, as it believes that the decline in real estate values is close to a plateau and the gap between buyers and sellers should narrow.

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It noted that around $1.6tn of real estate debt is set to mature in the next three years, with owners likely to come under pressure as they would have purchased properties at peak valuations and financed their debt at low interest rates.

“Given the rapid rise in interest rates over the past 18 months, many of those capital structures are now highly levered or over-levered,” Salem said. “While we think some loans will be modified, we also expect a significant number of owners will be forced to refinance or sell.”