Real Estate Credit Over Yield at Invesco – Charlie Rose

Charlie Rose · Invesco

Real estate credit has low correlation to public markets and has diversified both broad and alternatives portfolios.

Rose says real estate credit is characterized by low correlation to most other asset classes and to any public market, whether fixed income or equity. It has also been a good diversifier against private equity, private credit and real estate equity. It has diversified both broad portfolios and alternatives portfolios. He ties this low-correlation profile to the firm's decision to remove AI exposure from its portfolio, because many segments of the investable universe have meaningful AI exposure. The argument is qualitative, with no return or correlation figures given.

“Real estate credit is characterized by a low correlation to most other asset classes, low correlation to any public market, fixed income or equity asset classes... real estate credit has been a good diversifier in both a broad portfolio. Also in an alts portfolio.”at 20:19

Charlie Rose · Invesco

Banks' share of CRE lending has shrunk, and debt funds are filling the gap, sustaining the opportunity.

Banks are a smaller share of the real estate debt market than historically. Before COVID they held about 51% of the market, and today they hold roughly a third. Banks remain active in real estate credit, but the gap they have left is being filled by debt funds and alternative lenders like Invesco. Real estate credit is the fourth largest fixed income asset class in the US, at about $6 trillion. This structural shift is one of the two main drivers of Invesco's record deployment this year, with more than $5 billion of loans closed or committed.

“Banks are less active as a percentage of the overall real estate debt market than they have been historically. ... Historically, the banks were 51% of the market prior to COVID. Today, they're roughly a third of the market. That's left this gap that debt funds and alternative lenders such as ourselves have been filling.”at 21:44

Charlie Rose · Invesco

US commercial real estate faces about $3 trillion of debt maturities over five years, driving refinancing demand.

Rose says the lending market is being driven by an elevated maturity environment that he expects to persist for the next couple of years. He doesn't call it a wall of maturities, but expects roughly $3 trillion of real estate debt to mature over the next five years. This year is five years after the 2021 peak in loan originations, so many loans are coming due. That is materially increasing refinance activity, and more of the loans Invesco originates today are refinancings than historically.

“I don't necessarily talk about a wall of maturities, we are expecting $3,000,000,000,000 of real estate debt maturities over the next five years. And this year is five years after the prior peak of loan originations in 2021.”at 22:32

Charlie Rose · Invesco

Industrial and multifamily are the most liquid US property types, so Invesco focuses its lending there.

The vast majority of Invesco's volume is in industrial and multifamily, the 'sheds and beds' theme. Rose says these are the most liquid property types in the US, and that logistics is among the most liquid in Europe, where multifamily is less mature. That liquidity helps the firm underwrite multiple sources of repayment. Its relationship borrowers are also active in these two sectors. Multi-tenant logistics portfolios that are geographically diversified have a granular tenant base, so sector headwinds don't mean wholesale weakness in tenant profiles. He stresses selectivity at the asset level. In one Phoenix industrial deal, an asset manager rejected a building that looked like a slam dunk because it had worse truck parking and required three left turns off the interstate, making it the last building tenants would choose.

“Industrial and multifamily are the most liquid property types in The US. In Europe, logistics is one of the most liquid property types. The multifamily market is less mature in Europe. We like the liquidity profile that is helpful for us in underwriting multiple sources of repayment.”at 23:25

Charlie Rose · Invesco

Office is becoming underwritable again for good assets as values clarify, though it remains a hard asset class.

After COVID and the rate hikes, office saw faster and more acute value destruction than regional malls. Today there is more clarity on which office is in demand and which is not, and office buildings are selling, so values can be pegged with better certainty. For years Invesco wouldn't touch office, because it hates uncertainty and demand, rents and values were hard to underwrite. Now office is more underwritable, at least for the good stuff. Rose still sees office as a tougher asset class for a lender: it is capital intensive, with a high capex burden from continual leasing costs, it has more GDP correlation, and it has binary tenancy exposure. The firm has made just one office loan this year, in San Francisco's CBD, which it calls a first step after the recovery. In the Bay Area, a submarket close to the Caltrain station drew all tenant demand, so a building in another pocket of the same office park saw no tours in twelve months despite supportive backward-looking market data.

“Office buildings are selling in this environment. We can peg values with better certainty. ... Today, office is more underwritable, at least for the good stuff.”at 25:43

Charlie Rose · Invesco

Invesco sees excess yield for like-kind risk in European real estate credit due to information asymmetry.

Invesco has taken a constructive position on Europe, which differentiates it from peers. Rose argues that Europe lets the firm sometimes earn excess yield for the same risk as elsewhere, because information asymmetry is greater in that market. Lenders with better local information can price loans better than competitors.

“We have taken a constructive position on Europe that has been a differentiator relative to some of our peer sets. We see that we can, at times, generate some excess yield for like kind risk in Europe, given greater information asymmetry in that market.”at 45:58

Charlie Rose · Invesco

Invesco is growing exposure to industrial, outdoor storage and self-storage ("sheds") loans.

Invesco has been a long-standing lender in industrial, outdoor storage and self-storage, and says it has significant exposure there and is still adding to it. Rose treats these as the 'sheds' half of the firm's 'sheds and beds' theme, which is a view on where the firm sees value in property lending.

“We've been a long standing player in industrial outdoor storage and self storage. Those are areas where we have significant exposure and we're continuing to gain exposure”at 46:29

Charlie Rose · Invesco

Student housing is a major Invesco theme; it can yield fortress assets if locations are chosen carefully.

Student housing has recently become a major theme for Invesco. Rose warns that individual student markets are small and can face excess supply, so the strategy depends on location selection. He argues that well-chosen locations can produce fortress assets.

“Student housing recently has been a major theme of ours. You have to be careful in student housing because these individual markets are relatively small, they can be exposed to excess supply. But if you pick the right locations, they can be fortress assets.”at 47:02

Charlie Rose · Invesco

Invesco avoids lending on data centers because hyperscale single-tenant assets carry binary obsolescence and reuse risk.

Invesco's real estate credit platform does not lend on data centers, despite the sector looking tempting. Yields look attractive and supply of opportunity is immense, and tech valuations are exploding. Rose argues there is fundamental binary risk in data center investments. In hyperscale deals there is typically a single tenant, who may be investment grade today, but it is unclear how reusable the space is or what functional obsolescence will look like five, ten or twenty years out, and there is no alternative use for the building. This conflicts with the firm's credit-over-yield mandate of avoiding binary risk. He adds that most investors don't want the firm in data centers, and that many segments of the investable universe have meaningful AI exposure. Removing that exposure helps keep real estate credit's low correlation to public markets and other asset classes.

“We are not lending on data centers. ... we believe that there's fundamental binary risk in data center investments. In the hyper scaled situations, you oftentimes have a single tenant... it's unclear to us how reusable that space may be... And there's no alternative use.”at 19:04

Charlie Rose · Invesco

Wealth-channel capital into real estate debt is too small to fill the gap left by banks.

Several new entrants have raised wealth capital for real estate credit vehicles in recent years. Rose argues that the amount raised is a drop in the bucket relative to the overall market, and it does not come close to replacing the lending that banks have pulled back. He adds that for each new debt fund entrant, another manager that took losses in the last correction has left the market, so the fund-level picture is shrinking on net.

“There have been a number of entrants on the credit side in recent years. But if you look at the amount of wealth capital raised into real estate credit vehicles, it is a drop in the bucket relative to the overall market size, and is not coming close to filling the gap that is then left by the banks.”at 49:48