Your Take: Commercial Real Estate Due Diligence

Recently, two incidents have raised concerns about the commercial real estate market’s notable losses in triple-A Commercial Mortgage-Backed Securities (CMBS) in both the U.S. and the U.K. How should investors interpret these? And what kind of discussions are we at Opto having with our partners about real estate investment strategy?

These are the first such triple-A losses since the global financial crisis. Triple-A CMBS tranches are considered the safest part of a CMBS securitization, attracting the lowest yield due to their perceived lower risk profile.

The first incident involved a New York office building primarily occupied by L Brands, bought by Blackstone in 2014 for $600 million. Post-Covid, the tenant base dwindled, rendering the office space unattractive.

Recently, the property was sold for a third of its original purchase price, wiping out Blackstone's equity and resulting in investor losses in previously investment grade-rated debt.

The second incident, in June, involved a 2018 loan backed by three retail properties in the U.K., originally borrowed by Oaktree.

These secondary malls have been under pressure, with a significant decline in value. The property was eventually sold at a 60% devaluation for AAA-debt investors. The new buyer, however, acquired it at a current yield of about 15%, seeing potential in leasing up the available space.

Diversification and Commercial Real Estate Investing

While hindsight is always 20-20, these cases underscore the ongoing importance of diversification and maintaining optionality in changing environments. Even industry giants like Blackstone and Oaktree are not immune to market fluctuations and sector-specific challenges. For investors, the key lessons are:

• Be cautious of core, legacy assets: Particularly those in more challenged sectors like the two highlighted here: central business district (in New York in particular) office spaces and non-essential/secondary retail properties.
• Be selective and opportunistic: While troubled assets can lead to substantial losses, they simultaneously present the chance for strategic, opportunistic buyers to carefully play offense.
• Diversify: It is always a good idea to spread investments across various sectors and geographies to mitigate risks and capture potential upside in different market conditions.

In short, we shouldn’t generalize too broadly from these specific incidents, but the current market environment calls for a highly strategic approach to CRE investing.

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