COVID-19 Impact & Outlook – Alternative Investment Markets and Due Diligence Action Steps

Thursday, April 23rd, 2020 and is filed under AI Insight News

We recently hosted a webinar titled “COVID-19 Impact and Outlook, Alternative Investment Markets.” We were joined by three incredibly insightful speakers:

• Randy I. Anderson, Ph.D., CRE, President of Griffin Capital Asset Management Company
• Robert Hoffman, CFA, Managing Director, FS Investments
• Richard Kimble, CFA, Portfolio Manager, Americas for the Nuveen Global Cities REIT

See the key takeaways from our discussion with them as well as due diligence action steps provided by Mick Law, PC, or watch the full replay here:

Richard Kimble, Nuveen

• Real estate asset classes with shorter leases will suffer the most:
  • Hospitality, seniors housing, student housing, discretionary retail
  • Development will struggle
  • Some retail will close for good
• Industrial, non-discretionary retail, and housing are in a better position:
  • Multifamily and single-family rentals, life-sciences, technology (towers, data centers)
  • Housing still has demographic trend benefits and now may be more difficult to own.
• US will continue to be a safe haven for overseas investors. Manhattan will still be a focus, but some groups may look to diversify to other large US cities.
• Real estate transactions are down:
  • Of the deals awarded pre-crisis, some have gone through with purchases thinking this will be shorter-term V-shaped recovery, some backed out, and some pushed out 30-60 days to see if underwriting needs to be modified.
  • Transactions slowing down but once there’s normalcy there will be a lot of transactions.
• It is critical to use well-known and trusted valuation firms to properly assess risk:
  • They are using one of the largest third-party valuation firms that works with a number of clients and work with other appraisers similar to them to make sure the market is being consistent.
  • Making sure people are consistently pricing in risk is key.
  • For their fund, normally a third of the portfolio is appraised each month but during times like this they can appraise earlier.
• In Nuveen’s real estate platform, they have collected 94% of April rent.
  • A handful have asked for payment plans and they are using creative strategies that can be used to ease the pain of the deferred rent.
  • Not really working through force majeure because this doesn’t qualify for it or other MAC clauses, non-essential retail clients are struggling the most, but they want to be part of the solution to help make sure as many companies stay in business and keep as many employees – not abating rent but helping to defer.
  • For example, many retailers asking for deferral for the next couple of months. They can work with tenants to amortize or add on to the end.
  • They have set up a task force with a hotline to help small businesses access funds to stay in business.
• The real estate markets are in a stronger place than back in the global financial crisis (the GFC).
  • For example, CMBS issuance 2017-2019 was less than half 2006-2007 time period. There is more discipline in lending, looking at in-place cash flow vs. forward looking NOI, more equity in transactions.
  • Before COVID-19, they were maybe losing deals on the lending side due to pricing and structure or relationship, whereas before the GFC it was because other guy was giving more leverage. Covenants have also held up versus covenant lite environment pre-GFC.
• Looking at where traded REITs are now relative to NAV, and where spreads are, we’re seeing tremendous opportunities.

Robert Hoffman, FS Investments

• High yield bond markets will see volatility, defaults, downgrades, lack of CLO issuance, and fallout from the energy markets.
  • Defaults may hit 10% later this year, compared to mid-teens in the GFC.
  • Corporate bonds have proven to be resilient.
• There’s never been two years in a row that the HY debt market has been negative.
  • When looking at the history of the high yield bond markets, when spreads are as wide as they are now, or around 800bps, the median 12-month forward return is 26%.
  • This is probably not the time for broad, passive allocations, but the volatility creates opportunities.
• There will be volatility, but there are positives:
  • The speed to which the Fed came into the market with the stimulus packages is helping the markets work more normally so risk can be properly priced and help speed the recovery.
  • It also helps with resolving debt issues, if defaults or other actions can be worked out in a properly functioning market it lessens the impact.
• Public markets are seeing issuance and liquidity.
  • Debt is more expensive and more situational but its moving.
  • The fifth largest deal occurred last week amidst the pandemic.
• On the private debt side, most firms use reputable third-party valuation firms to mark to market as best and consistent as they can similar to real estate and there is also an analogous public market as an indication of value.
• Debt markets were so strong coming into this, and there is a fair amount of dry powder.
  • Funds are more properly leveraged and have built up cash and been more defensive even prior to COVID-19.
  • Most managers are taking care of their own book first, working with borrowers, and then will look to be opportunistic.
• Real estate debt is also in a better position than it was going into the GFC.
  • Debt service coverage ratios are better than before, LTVs are more appropriate.
  • Every downturn is different, but lenders are in a better position going into this.
• On the corporate debt side, there’s a much greater prevalence of covenant lite than pre-GFC:
  • It remains to be seen what impact this has on the market and this could prove challenging.
  • Covenant-lite loans recovered better than covenant-heavy post GFC but not sure that will happen again with significant weakening of fundamentals.
• Another factor that could be a challenge is a large shift to lower rated issuers from higher rated, and a higher percentage of loan-only Single B issuers as opposed to those issuing a loan and bond. However, ratings are higher than ever in history in the high-yield market and asset coverage is stronger than ever which may offset challenges.

Dr. Randy Anderson, Griffin Capital

• There will be volatility and the full impact depends on how long the virus takes to work its way through
  • In this downturn as opposed to the GFC, two of the three legs of the chair are stable – fiscal (stimulus packages) and monetary (interest rate reductions) are a positive.
  • The virus is the third leg and is variable. There is reason to be optimistic about a recovery in Q3 2020 but more likely in Q4.
  • The IMF is forecasting the US economy to be down 6% 2020 and then stronger in 2021, up 4.7%.
• Markets have stabilized recently as the majority of the fear has been priced in.
• Many managers were already somewhat defensive going into this based on high real estate prices and low cap rates.
  • They were expecting slower GDP growth anyways and were focused on defensive sectors including multifamily and industrial and had increased liquidity.
  • Like Nuveen, they are seeing high levels of collections on multifamily. People need a place to live.
• Public REIT markets overreacted by a factor of almost 3 times during the GFC and proved to be a great investment post GFC.
• The forecast for real estate over the five to seven-year period hasn’t change, with 4-6% income and a similar amount based on appreciation based on inflation rates. With bumps and volatility. No one makes money trying to time the bottom.
• They have employed low leverage and lines of credit were not drawn (similar across many managers), so now they can take advantage of opportunities.
• May take some time to accurately price in risk, but most managers use highly competent third-party valuation experts who follow standards that are widely adopted. The standards require them to look at all conditions and fairly reflect those values.
• One of the main things investors can be looking at is if managers have unfunded commitments.
  • It may be harder to raise capital in this environment, so you don’t want to have many outstanding unfunded commitments.
  • Also want to have enough cash on hand, liquid securities if it is possible in fund structure, and lines of credit.
  • It is important to play defense and then you also want to be positioned to play offense, when the third leg the virus starts to mitigate then markets will start to move and you want to be able to accretively acquire.

Due Diligence Action Steps (Provided by Mick Law, PC)

• Monitor for status updates for funds you have exposure to.
  • Monitor for any suspensions of an offering, share redemptions, or distributions (AI Insight Alerts) and immediately communicate to investors.
  • Proactively communicate the potential.
• Questions to ask sponsors in your discussions with them include have they:
  • Taken any proactive measures to protect asset value?
  • Adequately providing “specific information” to investors in offering materials and public filings about how COVID-19 “currently” affects, and may reasonably effect in the future, the operations and liquidity of such sponsors and their managed investment programs? The SEC has advised that it intends to monitor how companies are communicating with their investors concerning the effects of COVID-19.
  • Able to service its debt and any portfolio debt?
  • Able to continue operating without syndicating additional offerings in the short-term? (review financials)
  • Adjusting their distribution payment policies appropriately to account for the present and future effects of COVID-19?
• For oil/gas sponsors that use reserve-based lines of credit,
  • Are they appropriately prepared to address borrowing base deficiencies and related loan repayments in the probable event that their credit limits are adjusted due to lower commodities prices?
• For qualified opportunity fund (“QOF”) sponsors with identified asset funds,
  • What adjustments are they having to make to development timelines?
  • Do they still anticipate being able to meet the 30-month timeline to have their capital invested?
  • If not, are they reserving money to pay any potential penalties?
• For QOF sponsors with partial or complete blind pool funds,
  • What percentage of capital is already committed to projects (i.e., do they have capital available to take advantage of declining asset prices)?