Peachtree Group CEO Greg Friedman and CFO Jatin Desai hosted Dennis Lockhart, former President of the Atlanta Federal Reserve for a fireside chat conversation during Peachtree Group's annual Investor Day. Lockhart spoke on the US economic outlook, Federal Reserve policy, geopolitical risks and commercial real estate trends.
Here are key highlights from their discussion.
Dennis Lockhart, former President of the Atlanta Federal Reserve talks with Peachtree CEO Greg Friedman and CFO Jatin Desai about the US economic outlook, Federal Reserve policy, geopolitical risk sand commercial real estate.
Summary of the Economy:
The U.S. economy is performing well with steady growth. First-quarter growth was around 1.3-1.4% annualized GDP, but underlying indicators suggest stronger performance, with the Atlanta Fed projecting 3.1% annualized GDP growth for Q2 2024.
Unemployment is low at 4%, with recent job gains of 272,000. The private sector, especially healthcare, is driving job growth, leading to a more sustainable employment market and supporting consumer spending.
Strong employment ensures income stability for consumers, driving sustained consumption, which constitutes about 70% of GDP.
Inflation has decreased from its peak but remains above the Federal Reserve's target. The Fed prefers the Personal Consumption Expenditure (PCE) Index over the Consumer Price Index (CPI), with the current core PCE inflation rate at 2.7-2.8%, still above the 2% target. While adjusting the target inflation rate from 2% seems highly unlikely due to the Fed’s strong commitment and public trust in this goal, a more flexible approach within a defined range might be possible. This allows the Fed to address inflation without formally changing the target, leveraging the current economic strength to be patient and let inflation decline over time.
Federal Open Market Committee’s Perspective:
The Federal Open Market Committee (FOMC) is committed to making decisions on interest rates and monetary policy without political influence. Over a decade of attending meetings, Dennis has rarely seen political considerations come up. However, by tradition, the FOMC avoids action in the meeting immediately before a national election to prevent any appearance of political bias. Under Jay Powell's leadership, if necessary, the FOMC would act in September, but current conditions likely won't force action until after the election.
While different policies implemented by the elected candidate could shape the economy in the long term, the election itself is not anticipated to have an immediate impact. However, if post-election circumstances lead to significant disruptions, it could give the Federal Reserve pause at their November meeting.
If inflation doesn't improve or disinflation stalls at around 2.7-2.8%, the Fed may need to raise rates further. Conversely, consistent positive disinflation data could lead to rate cuts by year-end. There are several scenarios to consider:
Sticky Inflation: If inflation remains high, the Fed might raise rates toward the end of the year or early 2025.
Disinflation Resumption: Positive disinflation data could lead to rate cuts in November or December.
Economic Slowdown: If the economy shows signs of faltering and businesses anticipate a recession, resulting in layoffs and reduced consumer spending, the Fed might cut rates to stabilize the situation.
Financial Instability: A financial stability event, similar to the Silicon Valley Bank incident last year, could prompt the Fed to cut rates to address underlying banking system issues, especially in commercial real estate.
The FOMC's narrative is that the economy is gradually slowing down. The employment picture remains very positive and strong, though it is rebalancing and not as robust as in 2022 and 2023. Inflation is still elevated, but the FOMC believes disinflation will resume, allowing them to begin easing policy restrictions by the end of the year. However, all of this depends on how the data comes in and the overall economic picture painted by the upcoming months. Upcoming Fed meetings are scheduled for July, September, November, and December. Policymaking remains cautious, with an emphasis on waiting for clear trends in inflation data before making further changes.
Geopolitical Risks:
Geopolitical events can significantly impact financial markets and potentially change the economic outlook for the U.S., at least temporarily. These events, often unexpected, can disrupt equity markets and influence the economy. However, the Federal Reserve tends to be largely oblivious to geopolitics. Despite being close to the State Department, the Fed staff, mostly PhD economists, focus primarily on domestic issues and rarely consult with experts on geopolitical matters. This domestic focus means that while geopolitical events are serious and can influence the economy, they are not heavily factored into the Fed's policy decisions or economic projections.
Monetary Policy:
The balance sheet is a central tool for monetary policy. When interest rates hit zero during the Great Recession and the pandemic, the Fed used quantitative easing (QE) to stimulate the economy by increasing bank reserves, which supports lending and adds liquidity to financial markets. This led to the significant expansion of the Fed's balance sheet.
Currently, the Fed is slowly reducing its balance sheet to withdraw stimulus from the economy. This process, known as quantitative tightening, aims to find a new balance that provides ample bank reserves and liquidity without disrupting credit markets. The Fed approaches this carefully to avoid financial instability, such as the incident that occurred during a previous tightening attempt. This balance sheet adjustment is a critical but often behind-the-scenes aspect of monetary policy.
Fiscal Policy:
Fiscal policy, especially deficit spending, boosts demand and contributes to inflation. During the pandemic, significant stimulus measures supported households and businesses but also added to inflationary pressures. However, inflation is a global issue and not solely caused by domestic fiscal policy.
Federal Reserve Chairman Jay Powell acknowledges the unsustainable fiscal situation due to high debt levels but avoids criticizing Congress. The Fed factors in fiscal policy as one of many economic influences, recognizing its role in supporting growth, which can conflict with the Fed's inflation control efforts.
The Treasury's debt issuance strategy affects the bond market and banks holding these securities. Fiscal and monetary policies often create conflicting pressures, but the Fed incorporates these effects into their economic assessments and decisions.
Banking Sector:
Banks, particularly regional and community banks, have significant exposure to commercial real estate, making up around 40% of the market. While national banks have less exposure, the real estate market downturn has affected all banks, with properties like office spaces experiencing severe value declines and multifamily properties down by nearly 30% from their peak values due to high interest rates. Despite Federal Reserve Chair Powell's reassurances about the banking system's stability, there are concerns about the real-time recognition of crises. Historical precedent suggests that crises often go unnoticed until they are well underway.
The upcoming maturities of approximately $850 billion in commercial real estate loans present a potential risk. The exposure is dispersed across various financial entities, which is somewhat reassuring. However, small and regional banks are particularly vulnerable. The failure of a significant regional bank due to real estate exposure could have severe economic repercussions, unlike the manageable impact of community bank failures.
Banks are currently managing the situation by extending loan maturities, effectively buying time to stabilize individual properties. While this approach can mitigate immediate issues, it also reduces banks' lending appetite. A significant reduction in credit availability, particularly for small businesses that rely on smaller banks, could trigger a recession. This dynamic highlights the delicate balance between managing existing problems and maintaining sufficient credit flow to support economic activity.
Commercial Real Estate:
The near-term and long-term valuations of commercial real estate, particularly in hospitality, will depend on market fundamentals. The office sector faces significant challenges due to the rise of remote work, which could reduce long-term demand for office space. Companies are still figuring out their office policies, with some adopting hybrid models.
The retail sector is affected by online shopping, and the hospitality sector is recovering from the pandemic but hasn't fully rebounded. There are no major issues expected in hospitality unless there is overbuilding.
Office spaces were already saturated pre-pandemic, and suburban offices now struggle to find tenants. Many offices remain underutilized, with some businesses likely to stay remote. Converting office buildings to apartments is often not feasible due to technical constraints.
The multifamily housing sector continues to show strong demand and remains a stable area in commercial real estate.
ATLANTA (June 24, 2024) – With ongoing credit market dislocations, Peachtree Group originated a $40 million retroactive CPACE loan to BLG SAN DIEGO, LLC (BLG) for its recently opened 147-room AC Hotel San Diego Downtown Gaslamp Quarter in Calif. The Commercial Property Assessed Clean Energy (CPACE) financing was amortized over 30 years and required no payment for a year, followed by five years of interest-only payments. Also, the proceeds allowed BLG to pay down its senior loan with California-based Preferred Bank and E. Sun Commercial Bank, Ltd. to under $20 million, there by mitigating the banks’ exposure.
“This innovative capital structure significantly alleviated the immediate financial pressures, enabling the hotel to establish a solid cash flow foundation during its initial years of operation,” said Greg Friedman, Peachtree Group’s managing principal and CEO.
Despite the U.S. hotel industry's strong RevPAR performance, multiple headwinds exacerbate financial stress for owners. These headwinds include the lagging profitability of U.S. hotels, persistently high interest rates and historically high property insurance costs.
AC Hotel San Diego Downtown Gaslamp Quarter
“When we opened the AC Hotel San Diego Downtown Gaslamp Quarter in March 2023, there was a sizeable disconnect between hospitality fundamentals, which are strong, particularly in San Diego, while the debt markets were deteriorating meaningfully,” said Brad Honigfeld, founder, chairman and co-CEO of the New Jersey-based Briad Group®.“ The Fed’s tightening process and rising fund rates drove up the cost of debt considerably.”
Hotel and commercial real estate owners face a tough few years as trillions of dollars in debt come due, and refinancing gets harder, compounded by banks' tightened lending standards.
According to JLL Research, by the end of 2024, $5.8 billion worth of U.S. hotel-securitized loans will be due for repayment, requiring full payment, refinancing, extension or sale. However, if these loans were refinanced at current interest rates, most would struggle to generate enough income to cover their debt costs.
In this challenging lending market, Commercial Property Assessed Clean Energy (CPACE) financing has become a vital source of liquidity. This option is growing in importance as owners face impending debt maturities and scarce refinancing opportunities.
CPACE financing has rapidly gained traction in the commercial real estate market, reaching a cumulative $7.2 billion in the U.S. in just over a decade, according to PACENation. This significant milestone underscores the growing acceptance and adoption of CPACE financing as an innovative and effective solution. Peachtree Group, a key player in this market, has demonstrated its commitment to CPACE financing, with over $800 million in CPACE originations.
The AC Hotel San Diego Downtown Gaslamp Quarter is in downtown San Diego's Gaslamp Quarter, known for its restaurants, shops and nightlife.
“Our hotel was benefiting from its location and performing to its original underwriting, but the debt costs were straining cash flows,” Honigfeld said.
Retroactive CPACE funding offers unique advantages for property owners. It operates similarly to normal pre-project funding, with one key difference: 100% of the loan proceeds can be used to reimburse the property owner for costs already incurred. This feature makes retroactive CPACE a valuable resource for property owners seeking better loan terms or improved cash flow for completed projects.
“The financial relief it provides not only ensures the hotel's success but also positions it for long-term stability. By reducing the financial burden in the early years, owners can focus on delivering exceptional guest experiences and achieving operational excellence,” Friedman said.
This strategic approach paves the way for the asset to transition to a more favorable financing market in the future, ensuring its sustained profitability and growth.
About Peachtree Group Peachtree Group is a vertically integrated investment management firm specializing in identifying and capitalizing on opportunities in dislocated markets, anchored by commercial real estate. Today, the company manages billions in capital across acquisitions, development and lending, augmented by services designed to protect, support and grow its investments. For more information, visit www.peachtreegroup.com.
Peachtree Group Closed 17 loans totaling more than $244MM in the last 90 days
Peachtree Group is a nationwide direct balance-sheet lender, offering competitive terms, in-house loan servicing, and flexible capital to handle a wide array of projects.
Peachtree provides full-stack debt capital solutions to qualified commercial real estate owners across all sectors throughout the U.S. We offer bridge, construction, mezzanine, preferred equity, CPACE, permanent and NNN financing.
See below for some of the most recent loan transactions from Peachtree Group including hotel loans, retail, multifamily, industrial, and land. Click here for our portfolio.
Need Financing? Contact us at lending@peachtreegroup.com.
FEATURED: $20.5MM Development Loan for a Conversion
Peachtree Group worked with the Sponsor to convert a retail store to an industrial building in a sought-after area of Sacramento, CA.
Peachtree Group worked with the Sponsor to pay off its maturing loan while executing a business plan to upgrade its property to better compete in the marketplace and retain its Hilton flag.
Peachtree Group welcomed Mark Zandi, Chief Economist at Moody’s Analytics, for our most recent Market Update. Mark is responsible for directing economic research across macroeconomics, financial markets and public policy and offered his insights into the U.S. economy's performance and near-term prospects, highlighting reasons for optimism while focusing on the stabilizing benefits for commercial real estate and private credit investments amid moderating inflation.
Here are some key highlights from his presentation:
Economic and Market Performance:
2023 Real GDP Growth: Approximately 2.5%, surpassing expectations and indicating a strong year despite initial downturn concerns.
2024 Real GDP Growth: Projected at around 1.5% for the first half, with an expectation of about 2% for the full year.
Unemployment: Currently just over 4%, a slight increase from previous years but still considered low.
Inflation: Continues to moderate, with current levels very close to the Federal Reserve's target of 2%.
Long-Term Rates: The 10-year Treasury yield is expected to stabilize around 4-4.5%, with mortgage rates potentially settling just below 6%.
Commercial Real Estate: The market is adjusting, particularly in the office sector, but overall price declines and transaction volumes are expected to stabilize over the next couple of years.
Positive Developments:
Supply-Side Improvements: Increased immigration, productivity, and a surge in U.S. oil production have helped ease inflationary pressures.
Consumer Spending: High-income households are in a strong financial position, driving the economy forward despite struggles among lower-income households.
Potential Risks:
Federal Reserve Policy: Concerns that if the Fed does not cut rates soon, it could lead to financial instability.
Election Outcomes: Potential for social unrest and policy uncertainty depending on the results.
Long-Term Fiscal Issues: High debt-to-GDP ratios and the potential for future fiscal crises if long-term fiscal challenges are not addressed.
Investment Environment:
We, too, are optimistic about the economy and believe a soft landing is the most likely scenario, aligning well with how we are investing our capital. While certain commercial real estate investments will experience challenges as they're calibrate to a higher-for-longer interest rate environment, it still remains a favorable climate for Peachtree Group’s near- and long-term capital investments in credit, as well as opportunistic strategies, including development in the hotel sector for the coming years. Overall, many of the overarching themes Mark discussed echo what we have observed in the market, specifically:
Stabilizing Interest Rates: The highly dislocated lending environment, with $2 trillion in loans maturing in the next three years, becomes more manageable as 10-year Treasury yields and mortgage rates stabilize, creating a predictable environment for financing and refinancing commercial real estate projects. This could lead to increased investment activity.
Inflation Moderation: As inflation moderates, cost pressures on property operations and development ease, enhancing profitability and investment returns.
Consumer Spending: Strong consumer spending, especially from high-income households, supports demand for commercial spaces in retail and hospitality sectors, despite current challenges.
Private Credit Opportunities: The dislocation in traditional lending markets creates significant opportunities for private credit investments, offering attractive, equity-like returns with relatively lower risk due to substantial equity buffers in transactions.
Regulatory Environment: Regional banks facing pressures may retreat from commercial real estate lending, opening opportunities for alternative lenders. This benefits private credit investors and those with capital for loan purchases and recapitalizations, leveraging the firm's disciplined processes and strategic real estate ownership.
Mark Zandi, Moody's
Mark Zandi is chief economist of Moody’s, where he directs economic research. Moody’s is a leading provider of economic research, data and analytical tools. Zandi was a co-founder of Economy.com, which Moody’s purchased in 2005. He is on the board of directors of MGIC, the nation’s largest private mortgage insurance company; is the lead director of Policy Map, a data visualization company; and is on the board of the Coleridge Institute, a non-profit that facilitates the use of data across federal, state and local governments. An influential source of economic analysis for businesses, journalists and the public, Zandi frequently testifies before Congress. He is the author of Paying the Price: Ending the Great Recession and Beginning a New American Century, which assesses the monetary and fiscal policy response to the Great Recession. His other book, Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis, has been described by the New York Times as the “clearest guide” to the financial crisis. Zandi earned his BS from the Wharton School at the University of Pennsylvania and his PhD from the University of Pennsylvania, both in economics.
Lionsgate and Roadside Attractions have taken North America to the Nicolas Cage feature The Surfer which received a six-minute standing ovation at Cannes following its midnight section premiere. A 2025 theatrical release is planned. Read more on Deadline.
ATLANTA (July 2, 2024) – Peachtree Group (“Peachtree”) announced that it received multiple Marriott Select Brands (MSB) Awards during this year’s Marriott Select Brands Owner & Franchisee CONNECT Conference in Orlando, Fla. The awards recognize hotels that demonstrate outstanding service, innovation and commitment to guest satisfaction.
“These awards are a testament to the exceptional work our hotel associates deliver every day,” said Steve Mackenzie, Peachtree’s senior vice president of operations, hospitality management. “These hotels have consistently excelled in guest and F&B satisfaction, setting a benchmark for unparalleled service, and we are proud to have them as part of the Peachtree family. Additionally, we extend our gratitude to our partners who entrust us with managing their properties. Their collaboration has been instrumental in achieving these accolades, showcasing our shared commitment to superior quality.”
The award winners include:
Platinum Circle
· SpringHill Suites Lindale, Texas
Gold Circle
· Fairfield Inn & Suites Gadsden, Alabama
· SpringHill Suites Dallas Rockwall, Texas
· TownePlace Suites Dallas Rockwall, Texas
Silver Circle
· Courtyard by Marriott Indianapolis Plainfield, Indiana
· SpringHill Suites Vero Beach, Florida
F&B Satisfaction
· SpringHill Suites Lindale, Texas
“Every recipient of these awards embodies the essence of Peachtree’s mission, showcasing outstanding excellence, strong leadership and a relentless dedication to serving our guests, partners and communities,” said Shara Roddan, vice president of operations, hospitality management.
About Peachtree Group Peachtree Group is a vertically integrated investment management firm specializing in identifying and capitalizing on opportunities in dislocated markets, anchored by commercial real estate. Today, the company manages billions in capital across acquisitions, development and lending, augmented by services designed to protect, support and grow its investments. For more information, visit www.peachtreegroup.com.
NASHVILLE (June 25, 2024) – Peachtree Group originated its first commercial property assessed clean energy (CPACE) financing in Tennessee with a $10.7 million loan for a Class-A office development in Nashville. This marks one of the first properties in the city of Nashville and Davidson County to utilize CPACE.
The four-story, 75,000 sq. ft. office building at 1621 Ensley Blvd. is situated between Nashville’s central business district and the Wedgewood-Houston district. The CPACE financing, set over a 30-year term, will fund the office’s lighting, building envelope, HVAC, plumbing, and roof using a combination of retroactive and future funding. Division Street Development is developing the project, with a targeted completion date of October 2024.
Office and commercial real estate owners face challenging years ahead, with trillions of dollars in debt maturing and refinancing becoming more difficult due to tightened bank lending standards.
Peachtree Group originated its first commercial property assessed clean energy (CPACE) financing in Tennessee with a $10.7 million loan for a Class-A office development in Nashville. This marks one of the first properties in the city of Nashville and Davidson County to utilize CPACE.
“For eligible projects, CPACE financing remains one of the most attractive options to bring a project to completion. We are pleased to assist Division Street Development in securing the final piece needed to complete the financing puzzle for their office development,” said Jared Schlosser, Peachtree’s executive vice president and head of CPACE.
CPACE programs offer a unique opportunity for property owners to finance the up-front cost of energy or other eligible improvements on a property. This is then repaid over time through a voluntary assessment, as outlined by the U.S. Department of Energy. In Tennessee, property owners can leverage CPACE financing up to 25% loan to value, providing a flexible and sustainable financing option.
In 2021, the Tennessee State legislature passed CPACE enabling legislation, allowing counties or cities to establish CPACE programs.
Peachtree Group Credit is a direct commercial real estate lender offering permanent loans, bridge loans, mezzanine loans, CPACE financing and preferred equity investments across all commercial real estate sectors.
About Peachtree Group Peachtree Group is a vertically integrated investment management firm specializing in identifying and capitalizing on opportunities in dislocated markets, anchored by commercial real estate. Today, the company manages billions in capital across acquisitions, development and lending, augmented by services designed to protect, support and grow its investments. For more information, visit www.peachtreegroup.com.
ATLANTA (June 24, 2024) – Peachtree Group, a leading private equity firm specializing in identifying and capitalizing on opportunities in dislocated markets, has been proudly named to Inc.'s annual Best Workplaces list. This prestigious recognition not only highlights our company's excellence but also our team's dedication to creating exceptional workplaces and company cultures. This award is a testament to our continuous growth and success, further solidifying our previous Top Place to Work recognition from USA Today.
"Recognitions like Inc.'s annual Best Workplaces and USA Today's Top Places to Work are particularly meaningful to us because they reflect our team members' positive feedback, something we deeply value," said Greg Friedman, Peachtree's managing principal and CEO. "Winning these awards demonstrates our commitment to culture and inclusion truly resonates with our team. We believe in providing a healthy work/life balance to support our team members. When our team feels cared for, they show even stronger commitment to their work, leading to positive business impacts and increased employee engagement."
Inc. selected 543 honorees this year. Each nominated company participated in an employee survey, which included topics such as management effectiveness, perks, fostering employee growth and overall company culture.
"Each year, Inc.'s Best Workplaces program recognizes the very best in terms of companies that have fostered a truly amazing culture," says Inc. editor-in-chief Mike Hofman. "We use hard metrics and data as well as qualitative measures for judging in order to find the very best—and we're proud that the program is highly selective."
In addition to being named as one of Inc.'s Best Workplaces and USAToday’s Top Place to Work, Peachtree’s Friedman, Jatin Desai, managing principal and CFO, and Daniel Siegel, principal and president, credit, were recipients of GlobeSt.’s 2024 Best Bosses in Commercial Real Estate Award, celebrating leaders who exemplify ambition, financial acumen, exceptional people skills and inspire innovation through their exemplary leadership. In addition, Michael Ritz, Peachtree executive vice president, investments, and Siegel were selected as Commercial Real Estate’s Aspiring Leaders of 2024.
About Peachtree Group Peachtree Group is a vertically integrated investment management firm specializing in identifying and capitalizing on opportunities in dislocated markets, anchored by commercial real estate. Today, the company manages billions in capital across acquisitions, development and lending, augmented by services designed to protect, support and grow its investments. For more information, visit www.peachtreegroup.com.
Peachtree's track record in commercial real estate is impressive. Our team has thrived through three significant economic disruptions. Our senior leaders have been instrumental in that success. Recently we asked those leaders to reflect on their lessons learned and share how that experience has shaped their thought process moving forward.
Here are a few of those insights.
Lessons Learned with Peachtree Leaders Managing Principles
"Building a formidable team is crucial for realizing your vision. Select individuals based on their exceptional skills and expertise and then trust them to excel in their roles. Empowering your team unlocks their full potential, driving extraordinary results and propelling your organization to new heights."
Greg Friedman and Jatin Desai – Managing Principals
“Foresight is critical in the investment process, requiring continuous consideration of macroeconomic conditions alongside local economic factors. This dual analysis enables us to identify nuanced opportunities and manage risks more effectively. By integrating global and regional insights, we can make more informed and strategic decisions, enhancing the potential for the investment's long-term success."
Greg Friedman, Managing Principal and CEO
“Ensure sufficient liquidity to maintain resilience. We have implemented and consistently maintained this approach for our Funds. While it may impact internal rates of return (IRR), it will allow us to endure market volatility and retain assets. Asset values typically rebound if adequate capital is available to weather downturns.”
Jatin Desai, Managing Principal and CFO
Lessons Learned with Peachtree Leaders
“Navigating through development always entails its share of challenges and victories, a reality underscored especially during Covid. While previous downturns primarily revolved around financial aspects, the pandemic introduced disruptions in cost, labor, and material supply chains. Reaching a semblance of normalcy took nearly three years, during which we remained steadfast in risk mitigation across these fronts. Adaptations in processes, timing, procurement strategies, and collaborations with skilled contractors were pivotal in this regard. Despite each disruption, we observed a consistent upward trend in average daily rates, particularly for newer or like-new assets.”
Mitul Patel, Principal
“Anticipate various exit scenarios: While one of our investments succeeded with the SBA refinance strategy, another encountered challenges. Legal issues with the borrower disqualified them from SBA eligibility, leading to loan refinance challenges. In hindsight, we were too dependent on a single exit source and now underwrite deals to ensure there are several (refinance, sale, loan sale) exit options available.”
Michael Harper, President, Hotel Lending
“Constant exposure to various transactions across different levels has enabled us to recognize patterns and anticipate issues during negotiations. This depth of experience has honed our ability to streamline the process, focusing on the crucial issues and avoiding unnecessary distractions. Ultimately, efficiency is paramount.”
Kevin Cadin, General Counsel
“The priority lies in cultivating a pipeline rather than managing individual transactions. The true value lies in the pipeline itself, not the deals outlined in term sheets. This approach grants the freedom to negotiate without the pressure of immediate results. Consequently, I rarely push terms or additional proceeds because I know the depth of additional opportunities and have confidence in the channels that have been developed to continue generating opportunities.”
Daniel Siegel, Principal and President, CRE
“The90% rule. It is often better to make a decision with 90% of the information or90% of what you would ideally like an output to be. That last 10% which is for perfection often leads to analysis paralysis and the opportunity cost of waiting is often greater than the value achieved in getting the last 10%. There is no such thing as perfect.”
Peachtree Group recently had the privilege of hosting David Bitner, a renowned expert in the commercial real estate industry, on our quarterly market update call. As the global head of research for Newmark, a leading commercial real estate advisor, David's insights on the ongoing transition in commercial real estate (CRE) were invaluable. His discussion outlined a significant shift in the commercial real estate market, highlighting the transition from a low-interest rate environment post-Global Financial Crisis (GFC) to a period of higher rates that are reshaping investment strategies.
Highlights from the conversation included:
Interest Rates and Market Transition: The shift from historically low interest rates to a "more normal rate paradigm," emphasizing the end of a prolonged period of declining rates. This shift will likely affect all risk assets, including commercial real estate, by reducing the tailwinds that previously inflated asset prices and supported various investment strategies.
Impact on CRE and Investments: As interest rates rise, the cost of borrowing increases, impacting the valuation and affordability of real estate investments. This shift could lead to higher capitalization rates (cap rates) and change the dynamics of investment returns, making it crucial for investors to adapt their strategies accordingly. Floating rate debt, once considered a cheaper option, may no longer be the most economical option due to rising rates.
Market Volatility and Opportunities: While increased volatility in the market is expected as it adjusts to the new rate environment, it also brings a silver lining of opportunities. This can lead to both risks and opportunities. While some investors may face challenges, those with "dry powder" or readily available capital might find attractive entry points into the market, fostering a sense of optimism amidst the changes.
Long-term Outlook and Strategy Adjustments: Investors need to prepare for a sustained period of higher interest rates and adjust their strategies to remain viable. This includes expecting higher costs of debt and being cautious of investment valuations that do not adequately account for the new economic conditions.
Banking Sector and CRE Debt: There's a concern about the impact of rising rates on the banking sector, particularly smaller regional banks heavily invested in CRE loans. The potential for increased defaults and financial strain on these banks could lead to broader economic implications if not managed carefully.
Long-term Implications for Asset Values and Investment Returns: The long-term outlook is cautious, with expectations of continued market adjustment to the higher rate environment. This adjustment is anticipated to be gradual, with investors continuing to reassess risk and return parameters.
Overall, the discussion highlights a transformative period in the commercial real estate market, prompted by the shift to a higher interest rate environment. This change presents an opportunity to refine investment strategies, enabling investors to navigate and capitalize on the evolving market dynamics effectively.
Peachtree's track record in commercial real estate is impressive. Our team has thrived through three significant economic disruptions. Our senior leaders have been instrumental in that success. Recently we asked those leaders to reflect on their lessons learned and share how that experience has shaped their thought process moving forward.
Here are a few of those insights.
Lessons Learned with Peachtree Leaders Managing Principles
"Building a formidable team is crucial for realizing your vision. Select individuals based on their exceptional skills and expertise and then trust them to excel in their roles. Empowering your team unlocks their full potential, driving extraordinary results and propelling your organization to new heights."
Greg Friedman and Jatin Desai – Managing Principals
“Foresight is critical in the investment process, requiring continuous consideration of macroeconomic conditions alongside local economic factors. This dual analysis enables us to identify nuanced opportunities and manage risks more effectively. By integrating global and regional insights, we can make more informed and strategic decisions, enhancing the potential for the investment's long-term success."
Greg Friedman, Managing Principal and CEO
“Ensure sufficient liquidity to maintain resilience. We have implemented and consistently maintained this approach for our Funds. While it may impact internal rates of return (IRR), it will allow us to endure market volatility and retain assets. Asset values typically rebound if adequate capital is available to weather downturns.”
Jatin Desai, Managing Principal and CFO
Lessons Learned with Peachtree Leaders
“Navigating through development always entails its share of challenges and victories, a reality underscored especially during Covid. While previous downturns primarily revolved around financial aspects, the pandemic introduced disruptions in cost, labor, and material supply chains. Reaching a semblance of normalcy took nearly three years, during which we remained steadfast in risk mitigation across these fronts. Adaptations in processes, timing, procurement strategies, and collaborations with skilled contractors were pivotal in this regard. Despite each disruption, we observed a consistent upward trend in average daily rates, particularly for newer or like-new assets.”
Mitul Patel, Principal
“Anticipate various exit scenarios: While one of our investments succeeded with the SBA refinance strategy, another encountered challenges. Legal issues with the borrower disqualified them from SBA eligibility, leading to loan refinance challenges. In hindsight, we were too dependent on a single exit source and now underwrite deals to ensure there are several (refinance, sale, loan sale) exit options available.”
Michael Harper, President, Hotel Lending
“Constant exposure to various transactions across different levels has enabled us to recognize patterns and anticipate issues during negotiations. This depth of experience has honed our ability to streamline the process, focusing on the crucial issues and avoiding unnecessary distractions. Ultimately, efficiency is paramount.”
Kevin Cadin, General Counsel
“The priority lies in cultivating a pipeline rather than managing individual transactions. The true value lies in the pipeline itself, not the deals outlined in term sheets. This approach grants the freedom to negotiate without the pressure of immediate results. Consequently, I rarely push terms or additional proceeds because I know the depth of additional opportunities and have confidence in the channels that have been developed to continue generating opportunities.”
Daniel Siegel, Principal and President, CRE
“The90% rule. It is often better to make a decision with 90% of the information or90% of what you would ideally like an output to be. That last 10% which is for perfection often leads to analysis paralysis and the opportunity cost of waiting is often greater than the value achieved in getting the last 10%. There is no such thing as perfect.”
Peachtree Group CEO Greg Friedman and CFO Jatin Desai hosted Dennis Lockhart, former President of the Atlanta Federal Reserve for a fireside chat conversation during Peachtree Group's annual Investor Day. Lockhart spoke on the US economic outlook, Federal Reserve policy, geopolitical risks and commercial real estate trends.
Here are key highlights from their discussion.
Dennis Lockhart, former President of the Atlanta Federal Reserve talks with Peachtree CEO Greg Friedman and CFO Jatin Desai about the US economic outlook, Federal Reserve policy, geopolitical risk sand commercial real estate.
Summary of the Economy:
The U.S. economy is performing well with steady growth. First-quarter growth was around 1.3-1.4% annualized GDP, but underlying indicators suggest stronger performance, with the Atlanta Fed projecting 3.1% annualized GDP growth for Q2 2024.
Unemployment is low at 4%, with recent job gains of 272,000. The private sector, especially healthcare, is driving job growth, leading to a more sustainable employment market and supporting consumer spending.
Strong employment ensures income stability for consumers, driving sustained consumption, which constitutes about 70% of GDP.
Inflation has decreased from its peak but remains above the Federal Reserve's target. The Fed prefers the Personal Consumption Expenditure (PCE) Index over the Consumer Price Index (CPI), with the current core PCE inflation rate at 2.7-2.8%, still above the 2% target. While adjusting the target inflation rate from 2% seems highly unlikely due to the Fed’s strong commitment and public trust in this goal, a more flexible approach within a defined range might be possible. This allows the Fed to address inflation without formally changing the target, leveraging the current economic strength to be patient and let inflation decline over time.
Federal Open Market Committee’s Perspective:
The Federal Open Market Committee (FOMC) is committed to making decisions on interest rates and monetary policy without political influence. Over a decade of attending meetings, Dennis has rarely seen political considerations come up. However, by tradition, the FOMC avoids action in the meeting immediately before a national election to prevent any appearance of political bias. Under Jay Powell's leadership, if necessary, the FOMC would act in September, but current conditions likely won't force action until after the election.
While different policies implemented by the elected candidate could shape the economy in the long term, the election itself is not anticipated to have an immediate impact. However, if post-election circumstances lead to significant disruptions, it could give the Federal Reserve pause at their November meeting.
If inflation doesn't improve or disinflation stalls at around 2.7-2.8%, the Fed may need to raise rates further. Conversely, consistent positive disinflation data could lead to rate cuts by year-end. There are several scenarios to consider:
Sticky Inflation: If inflation remains high, the Fed might raise rates toward the end of the year or early 2025.
Disinflation Resumption: Positive disinflation data could lead to rate cuts in November or December.
Economic Slowdown: If the economy shows signs of faltering and businesses anticipate a recession, resulting in layoffs and reduced consumer spending, the Fed might cut rates to stabilize the situation.
Financial Instability: A financial stability event, similar to the Silicon Valley Bank incident last year, could prompt the Fed to cut rates to address underlying banking system issues, especially in commercial real estate.
The FOMC's narrative is that the economy is gradually slowing down. The employment picture remains very positive and strong, though it is rebalancing and not as robust as in 2022 and 2023. Inflation is still elevated, but the FOMC believes disinflation will resume, allowing them to begin easing policy restrictions by the end of the year. However, all of this depends on how the data comes in and the overall economic picture painted by the upcoming months. Upcoming Fed meetings are scheduled for July, September, November, and December. Policymaking remains cautious, with an emphasis on waiting for clear trends in inflation data before making further changes.
Geopolitical Risks:
Geopolitical events can significantly impact financial markets and potentially change the economic outlook for the U.S., at least temporarily. These events, often unexpected, can disrupt equity markets and influence the economy. However, the Federal Reserve tends to be largely oblivious to geopolitics. Despite being close to the State Department, the Fed staff, mostly PhD economists, focus primarily on domestic issues and rarely consult with experts on geopolitical matters. This domestic focus means that while geopolitical events are serious and can influence the economy, they are not heavily factored into the Fed's policy decisions or economic projections.
Monetary Policy:
The balance sheet is a central tool for monetary policy. When interest rates hit zero during the Great Recession and the pandemic, the Fed used quantitative easing (QE) to stimulate the economy by increasing bank reserves, which supports lending and adds liquidity to financial markets. This led to the significant expansion of the Fed's balance sheet.
Currently, the Fed is slowly reducing its balance sheet to withdraw stimulus from the economy. This process, known as quantitative tightening, aims to find a new balance that provides ample bank reserves and liquidity without disrupting credit markets. The Fed approaches this carefully to avoid financial instability, such as the incident that occurred during a previous tightening attempt. This balance sheet adjustment is a critical but often behind-the-scenes aspect of monetary policy.
Fiscal Policy:
Fiscal policy, especially deficit spending, boosts demand and contributes to inflation. During the pandemic, significant stimulus measures supported households and businesses but also added to inflationary pressures. However, inflation is a global issue and not solely caused by domestic fiscal policy.
Federal Reserve Chairman Jay Powell acknowledges the unsustainable fiscal situation due to high debt levels but avoids criticizing Congress. The Fed factors in fiscal policy as one of many economic influences, recognizing its role in supporting growth, which can conflict with the Fed's inflation control efforts.
The Treasury's debt issuance strategy affects the bond market and banks holding these securities. Fiscal and monetary policies often create conflicting pressures, but the Fed incorporates these effects into their economic assessments and decisions.
Banking Sector:
Banks, particularly regional and community banks, have significant exposure to commercial real estate, making up around 40% of the market. While national banks have less exposure, the real estate market downturn has affected all banks, with properties like office spaces experiencing severe value declines and multifamily properties down by nearly 30% from their peak values due to high interest rates. Despite Federal Reserve Chair Powell's reassurances about the banking system's stability, there are concerns about the real-time recognition of crises. Historical precedent suggests that crises often go unnoticed until they are well underway.
The upcoming maturities of approximately $850 billion in commercial real estate loans present a potential risk. The exposure is dispersed across various financial entities, which is somewhat reassuring. However, small and regional banks are particularly vulnerable. The failure of a significant regional bank due to real estate exposure could have severe economic repercussions, unlike the manageable impact of community bank failures.
Banks are currently managing the situation by extending loan maturities, effectively buying time to stabilize individual properties. While this approach can mitigate immediate issues, it also reduces banks' lending appetite. A significant reduction in credit availability, particularly for small businesses that rely on smaller banks, could trigger a recession. This dynamic highlights the delicate balance between managing existing problems and maintaining sufficient credit flow to support economic activity.
Commercial Real Estate:
The near-term and long-term valuations of commercial real estate, particularly in hospitality, will depend on market fundamentals. The office sector faces significant challenges due to the rise of remote work, which could reduce long-term demand for office space. Companies are still figuring out their office policies, with some adopting hybrid models.
The retail sector is affected by online shopping, and the hospitality sector is recovering from the pandemic but hasn't fully rebounded. There are no major issues expected in hospitality unless there is overbuilding.
Office spaces were already saturated pre-pandemic, and suburban offices now struggle to find tenants. Many offices remain underutilized, with some businesses likely to stay remote. Converting office buildings to apartments is often not feasible due to technical constraints.
The multifamily housing sector continues to show strong demand and remains a stable area in commercial real estate.
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