Talk Your Book: How Higher Rates Are Re-Shaping Commercial Real Estate

Jerry Baglien · Benefit Street Partners

Rate spike will slow CRE transaction volume, make refinancing harder and pressure property valuations.

Jerry says the jump in the 10-year yield, which is the base rate for real estate lending, is hitting every conversation he has. He expects it to slow transaction volume, make refinancings harder than they were, and put pressure on valuations. He describes these as multiple headwinds at once. He still frames them as opportunities for well-capitalized or inventive investors, and says the right response is caution plus opportunism, not fear.

“It's gonna slow down transaction volume for sure. It's gonna make refis trickier than they were, and it's gonna put pressure on valuation.”at 3:37

Jerry Baglien · Benefit Street Partners

Still avoiding office broadly; office is far more diverse and much of it has no long-term use case.

Jerry says his firm is still staying away from office almost categorically. He separates the few clear winners from a large group of assets that are hard to predict. He argues the pain is not in the shiny downtown towers, which are class A, new, and leased to large companies, but in suburban office, small-town office, and other older buildings where the long-term use case is much harder to argue for. He notes the picture is micro: buying downtown San Francisco may have caught the AI-driven upswing, but downtown Dallas probably would not have.

“Still staying away from office almost categorically.”at 7:48

Jerry Baglien · Benefit Street Partners

Multifamily valuations are tough, but cash flows persist and oversupply is being worked through.

Jerry says multifamily is a sector his firm has liked for a long time. Valuations are tough and returns have fallen, with occupancy issues and concessions as headwinds. But cash flows have not disappeared, so an owner does not lose half the building the way office owners can. Lenders can take more time rather than being forced into negative carry. He thinks the market has worked through a good amount of the oversupply that everyone has heard about. There is still a long-term need for the product. The uncertainty is timing: how quickly supply comes back before income grows and where rates settle for valuations. He still sees more safety there than anywhere else in CRE.

“it's much different than, you know, a sector which I've liked for a long time, which is multifamily, where, look, valuations are tough, but cash flows haven't disappeared.”at 8:04

Jerry Baglien · Benefit Street Partners

Real estate is not a one-to-one substitute for Treasuries; asset value and rent growth matter.

Jerry says comparing Treasuries and real estate is apples and oranges. Treasuries do not appreciate and do not produce rent growth, so a 5% Treasury yield does not mean cap rates should be 5.5%. A good asset run well can compound returns over a decade, and it is a hard asset that can be worth more at the end. Real estate can also be a better inflation hedge over time because rents should rise with other prices, though there have been exceptions.

“treasuries don't appreciate in value and you don't get rent growth on treasuries. And just because treasuries are 5% doesn't mean cap rates should be five and a half percent.”at 11:30

Jerry Baglien · Benefit Street Partners

Rate spike will make other lenders overly cautious, leaving room for disciplined lenders like his firm.

Jerry says competition is never zero: he competes with other debt funds as well as banks and insurers. He argues the rate run-up will pull things back and cause fear and extreme caution among other lenders. He argues the differentiator is consistency: staying within guardrails while remaining active in the market. In his view this is a time when disciplined lenders can differentiate themselves.

“I can tell you this run up in rates will will pull things back. This will cause some fear. Panic might be too strong a word, but extreme caution by other lenders.”at 14:30

Jerry Baglien · Benefit Street Partners

Maturing CRE loans must be resolved, so more recapitalizations or foreclosures are coming.

Loans made in 2021 and early 2022 at much richer valuations are maturing, including five-year agency loans, floating-rate value-add loans with extensions, and some seven-year bank loans. Lenders have kicked many of these down the road because nobody wants to foreclose in a messy market. Jerry argues they eventually have to be resolved. Owners will have to recapitalize, bring in subordinate partners, or the assets will go to foreclosure. He calls this a form of capitulation that is not a terrible outcome because it clears the market. Michael adds that he expects foreclosures to hit the market over the next year or so. Record origination in the early 2020s also has to be reckoned with in the next couple of years.

“You're either gonna have to re up and recapitalize some of these things, bring in some sort of subordinate partner to sustain it, or... you're gonna see more foreclosures”at 16:14

Jerry Baglien · Benefit Street Partners

Downturn split CRE outcomes: nicest, best-capitalized assets held value while older Sunbelt stock fell harder.

Jerry says a lot of money still chases the multifamily-in-the-Sunbelt story, and the focus on multifamily has only grown. The results were bifurcated. Newer, nicer assets did not see the same value depression as roughly thirty-year-old stock in the Sunbelt. The best-capitalized institutional investors moved to the nicest assets, which preserved more value, while the other bucket saw more severe outcomes. He says it is not as simple as everyone moving to Dallas or Austin. Results are very micro and asset-specific.

“The nicest assets preserved more value, but the other bucket had more severity in terms of outcome.”at 17:29

Jerry Baglien · Benefit Street Partners

Construction debt at 8-10% has depressed building, setting up a cyclical supply rebound in a few years.

Jerry says construction debt used to cost 5 to 6 percent and now costs 8 to 10 percent or more, depending on project risk. That doubling of the cost of capital makes developers reluctant to start projects. Multifamily construction is already fairly depressed after a wave of supply, and he expects it to snap back in a few years and start another cycle. He says this is why real estate is so cyclical: oversupply, then no one builds, then undersupply and everyone builds again. Building now means delivering into a supply picture that is hard to predict precisely.

“Everyone built everything in the world when you could borrow construction debt at 5% or 6%, but now it doubled.”at 19:00

Jerry Baglien · Benefit Street Partners

Industrial warehouse is a top allocation where banks have pulled back and his firm steps in as lender.

Jerry says industrial is his firm's second-largest asset allocation over the last couple of years and probably its biggest growth area. The main reason is that capital providers, especially banks, have stepped back for years. Industrial is one of the most acute spots in the market where capital has pulled back. That gives his firm room to step in as an alternative credit provider and take market share.

“We do a decent amount of industrial. I think it's been our second largest asset allocation the last couple years and probably the biggest growth part of our portfolio.”at 19:45

Jerry Baglien · Benefit Street Partners

Hospitality looks fine; resilient consumer spending means no near-term storm clouds for the sector.

Jerry says hospitality still generally looks good. The economy is running well, and the consumer seems pressured but remains remarkably resilient, with a high amount of disposable income and strong spending that has flowed through to hotels. He says he is not super bullish, but the sector has been fairly consistent and he sees no near-term storm clouds. He adds that inflation can help grow rents and ADR across asset classes, including hotels.

“I wouldn't say I'm super bullish on it, but I feel like it's been fairly consistent and you don't see any near term storm clouds on the horizon.”at 22:49

Jerry Baglien · Benefit Street Partners

Less optimistic on CRE equity until cap rates adjust; credit offers more cushion and conviction.

Jerry is less optimistic on real estate equity on a mathematical basis until cap rates adjust, because there is no negative leverage yet. Credit looks better to him for two reasons. There are plenty of transactions that need financing. He also says he cannot predict valuations or rates, so he prefers to invest where he has a cushion of equity beneath his position in the capital stack. He expects more twists and turns before the sector's problems are sorted, and sees this as a good time to be a lender. His conviction is higher, not lower, because of the correction.

“perspective today until you get some cap rate adjustments, you don't have negative leverage. It makes me like credit all the more.”at 24:59

Jerry Baglien · Benefit Street Partners

Low rates are not the norm; strong growth and AI investment will keep rates pressured higher.

Jerry says the sentiment is disappointment because people got used to the low-rate environment, but there is no reason to assume it was the norm. He says the higher rates are for not terrible reasons: awesome economic growth, an economy humming along without crashing, massive AI investment, and efficiency and productivity gains across the economy. Those strengths are expected to pressure rates. He argues firms should not be built around a paradigm that might no longer exist.

“just because rates were low doesn't mean they're gonna go back to being low. There's not a rule that says that has to happen. You've got higher rates for not terrible reasons.”at 10:14

Jerry Baglien · Benefit Street Partners

Scale matters more in asset management; consolidation favors large, diversified platforms.

Jerry says scale matters more and more in asset management, and consolidation continues across the board. Smaller players have disappeared over the last few years while the big names keep growing at good clips. Large, more diverse platforms will continue to win out. Competition does not disappear, though: lenders also compete with banks and insurers.

“I think scale just generally matters more and more in the asset management business, and and you continue to see consolidation there across the board.”at 13:54