DoubleLine Capital portfolio manager Morris Chen told Bloomberg in an interview that worries over the commercial real estate market have largely eased. He added that “draconian” scenarios that arose out of the bank problems early last year have been largely priced out of the markets.
The sentiment shouldn’t have been surprising. In a February report, the company wrote, “As the broader market has turned to pricing in the ‘when,’ not the ‘if,’ of future cuts to the federal funds rate, investor sentiment has improved with respect to CRE. We expect property transactions to increase, helping to provide clarity on CRE valuations.”
It didn’t seem exactly like a general statement about CRE. Instead, it was about CRE outside of the “unique convergence of cyclical and secular headwinds confronting part of the office market.” Because generally CRE fundamentals are good.
Chen said that the outlook is much better than last year, when DoubleLine had launched its CRE ETF. At the time, office loans were getting priced as though they were under a three-year extension with an expected 60% loss.
Even now, office leasing activity has been 30% off from pre-pandemic levels, according to the DoubleLine report. “We expect the normalization of hybrid working to continue to limit the growth of office demand,” they wrote. Higher-quality properties will continue to do well as buildings constructed since 2010 see positive net absorption. Older buildings feel the pain.
“There’s more of this ‘sharpen your pencil’ environment where investors are resetting their expectations,” Chen said. “The shift is the markets getting smarter or more efficient and people are more willing to roll up their sleeves and dig into this. That’s also a very healthy sign, it’s very akin to a stock pickers’ market.”
Even as worries about CRE have continued, particularly office, the amount of credit lately available to CRE borrowers has been “incredible,” according to Chen. Bloomberg collected data that shows $23.5 billion in non-agency CMBS lending have been issued this year so far.
“Inside of the two-year part of the curve is very interesting. It’s an area where if you want to play offense, you can play offense,” Chen said. “You need to find the right bonds, understand the structure, understand the dynamic in terms of the CMBS market, and that’s what we’re here to do.”