Oaktree Capital warns of high risk in commercial real estate market

Oaktree Capital, a distressed-debt firm, has issued a warning about the high risk present in the commercial real estate market. The co-CEOs of Oaktree Capital expressed their concerns regarding the substantial amount of debt that is due to mature in the coming years. They highlight commercial real estate as the most critical area of risk, with over $1 trillion of commercial real-estate loans set to come due in 2024 and 2025. In response to this risk, Oaktree Capital plans to employ strategies similar to those used during the global financial crisis, such as acquiring portfolios of commercial real-estate loans from banks and participating in “credit-risk transfer” deals. Additionally, the firm sees opportunities in private credit and leveraged loans, as well as potential challenges in the Treasury market.  

Commercial Real Estate Market Risk

Oaktree Capital, a major distressed-debt firm, has identified commercial real estate as the “most acute area of risk” in the current market. This assessment comes as a significant amount of debt in the commercial real estate sector is set to mature in the coming years. According to Oaktree’s co-chief executives, over $1 trillion of commercial real estate loans are scheduled to come due in 2024 and 2025. With this impending maturity wall, the risk of default and financial instability looms large. Oaktree Capital’s observation highlights the potential challenges and vulnerabilities present in the commercial real estate market.

Opportunities in Credit

Despite the risks associated with commercial real estate, Oaktree Capital sees significant opportunities in the credit market. The firm’s incoming co-chief executives, Armen Panossian and Bob O’Leary, believe that there is a $13 trillion market ripe for the taking. Within this market, they see potential in high-yield bonds, BBB-rated bonds, leveraged loans, and private credit. These segments of the market have grown substantially since the global financial crisis, now reaching nearly $3 trillion in size. Oaktree Capital aims to capitalize on these opportunities by strategically investing in credit instruments and identifying companies that are expected to remain strong even in the face of potential defaults.

Growing Risks in Commercial Real Estate

The challenges in the commercial real estate market are becoming increasingly apparent. As mentioned earlier, over $1 trillion of commercial real estate loans are set to mature in 2024 and 2025. This “maturity wall” poses a significant challenge as borrowers may struggle to refinance their loans. The recent retreat in the benchmark 10-year Treasury yield provides some relief, but it may not be sufficient to alleviate the difficulties faced by many borrowers. Additionally, there is a growing need for capital in office properties with vacancies and stagnant rental growth. Certain types of office properties are finding it difficult to access the necessary capital, further exacerbating the risks in the commercial real estate sector.

Relief from Decrease in Treasury Yield

The decrease in the benchmark 10-year Treasury yield has provided a measure of relief for borrowers in the commercial real estate market. The yield has retreated from its peak of 5% in October to around 4.1% as of now. The lower rates may make it easier for some borrowers to refinance their loans and manage their debt burdens. However, despite the decrease in Treasury yields, many borrowers may still face challenges in accessing refinancing options. This discrepancy between lower rates and limited refinancing opportunities highlights the complexities of the current commercial real estate market.

Capital Need in Office Properties

One of the key areas of concern in the commercial real estate market is the need for capital in office properties. Properties with vacancies and stagnant rental growth are facing difficulties in accessing the capital they require. This is especially true for office properties where borrowing rates have significantly increased over the past three years. The availability of capital for certain types of office properties is limited, further exacerbating the risks in the market. This shortage of capital poses challenges for property owners and may lead to increased defaults and financial instability in the commercial real estate sector.

Oaktree’s Playbook from the Financial Crisis

In response to the risks in the commercial real estate market, Oaktree Capital plans to dust off its playbook from the financial crisis. The firm intends to acquire portfolios of commercial real estate loans from banks, capitalizing on distressed opportunities in the market. Additionally, Oaktree plans to participate in credit-risk transfer deals that help lenders reduce exposure to potential defaults. By employing these strategies, Oaktree aims to navigate the challenges in the commercial real estate market and maximize its investment opportunities.

Opportunities in Private Credit and High-Yield/Leveraged Loans

In addition to seeking opportunities in the credit market, Oaktree Capital sees potential in private credit, high-yield bonds, and leveraged loans. The firm believes that several hundred companies that have issued such debt will remain strong even if defaults rise. Oaktree Capital’s expertise and experience in distressed debt make it well-positioned to identify these resilient companies and capitalize on the opportunities presented by private credit and high-yield/leveraged loans. Through careful analysis and strategic investments, Oaktree aims to generate strong returns and mitigate the risks associated with these markets.

Concerns in the Treasury Market

Oaktree Capital has expressed concerns about the 10-year Treasury yield and its potential impact on the market. The firm points to factors such as the U.S. budget deficit, supply, and the potential limitations of foreign buyers. Given the current economic landscape, including the deluge of supply and the possibility of foreign buyers being tapped out as owners of Treasury securities, the trajectory of the 10-year Treasury yield becomes a significant concern. Any significant movements in the Treasury market can have a ripple effect on various sectors, including commercial real estate and credit markets.

Impact on U.S. Stocks

The state of the commercial real estate market and the risks associated with it have had an impact on U.S. stocks. Following strong retail-sales data for December, U.S. stocks experienced a decline. This decline occurred despite the resilience of the U.S. economy, with the Federal Reserve maintaining its policy rate at a 22-year high. The uncertainties and vulnerabilities in the commercial real estate market have contributed to market volatility and influenced investor sentiment. As such, understanding and monitoring the developments in the commercial real estate market becomes crucial for investors and market participants.

Conclusion

In conclusion, the commercial real estate market poses significant risks in the current market environment. Oaktree Capital, a major distressed-debt firm, has identified it as the “most acute area of risk” right now. However, amidst the risks, opportunities arise in the credit market, private credit, high-yield bonds, and leveraged loans. Oaktree Capital believes that careful analysis and strategic investments can unlock value in these areas. It also emphasizes the need for capital in office properties and the potential challenges that borrowers and property owners may face. By understanding and navigating the risks and opportunities in the commercial real estate market, investors can make informed decisions and mitigate potential pitfalls.