Joe Iacono, Chief Executive Officer of Crescit Capital Strategies, offers thoughts on opportunities in the hotel industry and how the impact of the COVID-19 pandemic differs from the 2008-09 financial crisis.
Q: Tell us about Crescit Capital Strategies.
A: We're predominantly a middle-market capital provider operating in and around major markets throughout the United States. Our primary activities include making first mortgage loans, mezzanine loans, preferred equity investments and seeking opportunistic transactions, including distressed portfolios, distressed loans, and distressed sellers of loans.
Q: How does the COVID-19 crisis differ from the 2008-09 financial crisis?
A: There's more liquidity in the system today than there was during the 2008-09 financial crisis. The government responded faster to this crisis – in part, because it had the playbook from the 2008-09 financial crisis – and this resulted in the capital markets, equity markets, and bond markets stabilizing and recovering most of their value reasonably quickly.
Also, I think the dichotomy between underlying economic fundamentals, including employment and small business performance, versus what is happening in the capital markets is greater than during the financial crisis. I think that we've yet to feel the pandemic's full impact on real estate.
As far as underwriting loans today, to some extent, it's an issue of timing. If you believe that the health crisis is finite, one must project the financial impact and how long it will take to recover once there's a vaccine. Most people agree that hotels will come back at some point and that people will travel and stay in hotels again.
Part of the solution is to require larger interest and operating reserves, and you are probably underwriting little, if any, rent growth because you don't know how long it will take for things to recover. The overall result is more conservative underwriting to account for value adjustments to the underlying assets.
As far as the retail industry that was already experiencing issues pre-COVID around long-term demand, it is much tougher to project how things will look.
Q: Would you lend on a hotel in today's environment? What factors would you consider?
A: Yes, if the hotel asset was sound pre-COVID. I believe that the hotel industry will come back and that it is an interesting opportunity in today's market. While it has been among the hardest hit, it is a matter of timing and projecting carry costs until there is a return to normalcy.
Q: How do you see behavioral changes born out of the pandemic impacting certain asset classes long-term?
A: For offices, you can make as strong a case for companies requiring more space in the future as you can for them needing less space. I believe companies will require a larger footprint to keep employees spread out; however, we're also going to see companies become more tolerant and supportive of working remotely. I still believe that companies will require that employees spend some portion of their time working on site. Companies recognize that it is difficult for employees to collaborate, generate new ideas, and produce innovations while working remotely. I don't think that we're going to see the pendulum swing to such a degree that companies lose sight of the benefits of in-person working. If there is a contraction in the office space, I don't think it will be as big as one would think.
Q: What do you see in the market for loan modifications?
A: Generally, the banks have been extending and modifying loans to accommodate borrowers, while borrowers are inundating CMBS lenders with modification and extension requests. Whether the servicers are being responsive appears to depend on the servicer itself and the nature of the transaction. The GSEs were the first to provide forbearance, and there is not as much distress in that space. In some respects, the approach taken by the banks, CMBS lenders, and GSEs is working. The real question is: for how long?
Q: If you held a troubled hotel loan, what would you be looking to do with it? Is it too early to sell the note?
A: Every lender is dealing with this issue a bit differently. Most lenders that can hold their notes are not selling. For some lenders, it also depends on if they are getting margin calls from their repo or warehouse lenders. We saw this play out in the early stages of the crisis, where some lenders were forced to sell assets to generate cash. In the few sales we have seen thus far, lenders have obtained high dollar prices for hotel loans. In most of these cases, the buyers are owner/operators who like the loan basis and are prepared to own the assets. There seems to be a lot of capital in search of these types of opportunities. Today, there are not enough sellers. I expect this will change in the coming months.