Are there specific segments of the commercial real estate market that you think will be particularly vulnerable in an economic downturn?  

With a wide range of macroeconomic conditions affecting single-family, multifamily, and commercial real estate, we are seeing an impact on all classes of real estate. Real estate intersects with everything, from our homes, to consumer goods, to entertainment, health and wellness, and the beloved office. With each cycle, at least one asset class falls out of favor with investors and lenders. At the beginning of this cycle, we expect that to be the office for two reasons: 

1. It’s not consumer-facing and, therefore, it’s less likely to gain the attention of government stimulus intervention. Several cities have experienced a standing 20% vacancy rate in office supply during many cycles, and it’s the local government, not federal, that tries to come up with repurpose solutions or abatements.
2. We have adapted and embraced technology successfully. Whether it is remote or co-working in shared space, we have found that a Monday through Friday in-office route is not absolutely necessary (although I do believe that weekly time in the office is invaluable and creates upward mobility opportunities). 

After office, retail is the next asset class we believe will struggle. Retail is experiencing staffing and product delivery headwind. However, our retail experiences and expectations continue to broaden as we embrace online, on-demand, and immediate delivery, as well as 24/7 shopping with returns becoming easier and easier, sometimes to the point of keeping the product because it’s less expensive than returning it. The common thread between office and retail: shrinking footprints. Lodging may also show increased defaults due to the lack of government stimulus combined with government belt-tightening, as well as the hang-over of COVID-19 debt deferment or product improvement deferrals, creating an insurmountable amount of capital needs for debt and operations. 

When real estate borrowers fall behind on their payments to lenders, are there any immediate actions they should take to assure their lender that they’re going to be back on solid ground in the near future?

Absolutely, it is imperative to be transparent. Most real estate lenders interact with borrowers/sponsors via asset managers. Asset managers are managing numerous loans at one time (portfolios) and therefore lean into various professionals to assist in the management of the portfolio. Immediate actions borrowers should take include:

1. Retaining professionals (financial advisors, attorneys, etc) experienced in real estate workouts
2. Providing the lender/asset manager with a prompt response to all financial and informational requests (regardless of whether it has been previously provided)
3. Coordinating a site inspection and meeting with the lender to walk them through the collateral and the borrower’s proposed business plan
4. Submitting a proposal outlining the first steps for the resolution or restructure of the distressed event

What opportunities might a downturn present for investors in distressed commercial real estate, and what are the risks/pitfalls of which they need to be aware?

Real estate cycle downturns create opportunities once the bid-ask spread compresses. Investors will find opportunities through non-performing loans (notes), receiver sales, bankruptcy sales, and equity injections for non-stabilized assets. However, we expect there will be significant competition for acquisition of, or investment in, high demand asset classes (such as multifamily and industrial/warehouse) and low opportunity for investment in less desirable asset classes such as office, lodging, or retail. Investors should be wary of par transactions in today’s market (acquiring at a lender’s basis) and lack of consideration for an equity injection/recap, and should also understand the seller’s prior actions, which may travel with the paper or investment.