Inflation has left its mark
He summarized the impact last year had on business as inflation took hold, forcing the Fed to tinker with rates in attempts to tamp it down. “As the year progressed, we saw the starting of some pretty severe hikes in interest rates,” he said. “Today we’re at 4.5% on Fed funds, and we started out at 25 basis points,” he said in an interview earlier this week. “We’re up 325 basis points since this started.”
That’s left a mark: “So those are sharp rises in rates, and it has had resulting impact on commercial real estate – whether it is what debt costs today to create your leverage and deals, or whether or not those hikes in rates have impacted existing assets, existing portfolios, that are tied to floating rate debt.”
The current environment has been a spoiler, he suggested: “It’s been really hard for folks to not make money in real estate for the past 10, 12 years,” he said “Coming out of the financial crisis, we had a lot of free money, a very accommodative Fed, a very robust environment, so a lot of people made a lot of money. A lot of people who are newer into the industry really have not gone through cycles like we have,” he added. “We’ve been through a lot of cycles, and we understand it. But certainly, going into 2023 it is going to be more of a challenge.”
Tailoring tactics to go with the flow
McKnight detailed how RREAF Holdings navigated around the changing economic landscape: “As we wrapped up ‘22 and moved into ‘23, looking back and taking some assessments, probably the past 18 months leading up to the end of ‘22 we were able to take advantage of very strong pricing in the market to exit certain deals,” he said. “Gosh, I think we exited $700 million or more in assets over the past 18 months – very favorable execution for ourselves and our investors. You have a lot of capital out there chasing yield and chasing deals so there is somewhat of an imbalance – maybe where assets should’ve been priced versus what they were priced at. We definitely took advantage of that. However, over those same 18 months, we were still net buyers of assets because we had the capabilities, we had the capital available to us to be able to execute when there were opportunities.”
Learning from the past
He advised those who are newcomers to the CRE space to educate themselves on the past. “I would say read a lot, learn a lot, and try best to understand what history tells us,” McKnight said. “Everything that goes up comes down at some point. Right now, we’re in a transitional environment where there’s going to be a lot of opportunities. There are going to continue to be disconnects and sometimes those disconnects will move to the investor’s favor. Right now, we have some disconnects that are not necessarily in the investor’s favor given where leverage is costing versus where cap rates are currently on certain types of assets,” he said.