In our first AMA (Ask Matt Anything), Matt Malone discusses fears around the CRE market.
Hi, I'm Matt Malone, head of investment management here at Opto. Here at Opto we get a lot questions from advisors. One we hear a lot lately is what's going on with the U.S. commercial real estate market. Is it a bubble? What should be concerned about? What are the investment opportunities? And whenever we’re approached with questions like this, we try to think through it in the framework, and we use four key things to shape our thinking.
First, we want to look at the size of the overall market. Second, we want to analyze the issue and decide whether it's systemic or acute. Third, we want to look at whether there are any bright spots within that market. And then fourth, what are the opportunities, if any, to deploy capital based on this analysis? So when we're thinking about the U.S. commercial real estate market, and we want to determine the size of the market, there's a couple of metrics to look at.
First, the overall U.S. commercial real estate equity market is about $20 trillion. This represents about two-thirds of the market cap of the S&P 500. So it's a pretty large market. The observable commercial real estate debt market is a little over 5 trillion, which compared to other credit markets, is quite large as well. It's about the size of the high-yield market, the broadly syndicated loan market, and the private credit market combined. So overall, these are quite large markets. There's a lot of different dynamics going on within the U.S. commercial real estate market.
Second, what are the issues? Are they systemic or acute? And I think when people are talking about commercial real estate, the concerns these days fall into two categories. One, there's a broad-based, somewhat systemic concern with the rapid rise in interest rates and the ability of owners to refinance properties to the extent needed. Second, there's an acute concern with respect to office. And if you're focused on just reading the financial news, you might think all of commercial real estate is office. But in reality, only represents about 15% of the overall commercial real estate market. So there are some issues within the office sector, mainly within commodity office product and within potentially overbuilt metropolitan statistical areas as tenants change their use patterns for commercial real estate office space.
Third, what's going well? While in general, if you've been a commercial real estate owner in the United States and held property over the last 5 to 10 years, you're probably sitting on some decent gains. In addition, net operating income for properties have generally been on the rise. So the underlying fundamentals have been trending positive. Second, lenders have generally been more disciplined in the cycle post-global financial crisis, lending at lower loan-to-value ratios and higher debt-service coverage ratios.
Bringing all that together, what are the opportunities, and how should we be thinking about the commercial real estate market going forward? Well, first, there definitely are refinancing risks for legacy properties. So we want to think about the holdings that folks have already, and are they going to have any trouble refinancing in the near term? Is that going to impact how they're able to cover debt service going forward? Well, we've seen that the midsized community banks have been pulling back and commercial real estate lending. They're under a lot of pressure based on their current holdings and what's been going on in the banking environment. These banks generally represent about half of the commercial real estate debt market. This presents an opportunity for private lenders within the commercial real estate space, where a much smaller part of the overall commercial real estate lending landscape and may have dry powder to deploy selectively into good real estate lending opportunities. On the other end of the spectrum, in terms of commercial real estate investing, we think that opportunistic buyers now may have a good chance to deploy capital into good properties that may have bad balance sheets.
So bringing it all together, the US commercial real estate market is a large market. There are a number of different sectors with different dynamics. Overall, the market has been relatively healthy but now is presented with some problems related to refinance ing and changing uses of office. These problems will present opportunities for certain opportunistic parties that are ready to deploy capital.