Debt Investors, Prepare for Disappointment

Some players may be optimistic about the potential returns available in the U.S. debt market. Don’t count former CBRE Capital Partners president Ethan Penner among them. “The U.S. debt market is, in my mind, overfunded and therefore mispriced,” Penner says. “So I don’t really see that as a very exciting opportunity today. And if I did, I’d be out there raising a fund to do it. And I’m not.” The concentration of capital into large investment-management companies has created a “value disparity” between large and small deals, Penner believes. If a company has the operational capacity to pick up smaller deals, it is more likely to find relative value compared to larger deals. Penner is wary of the much-vaunted opportunities in the U.S. mezzanine lending space. “Why wasn’t it an opportunity in 2009 and 2010 and 2011?” he says. “And it wasn’t a very big opportunity. People, including me, thought it would be bigger than it would be.” He is likewise suspicious of the scale of the looming opportunities in the CMBS market. Penner believes the coming wave of maturities is not going to amount to the huge funding gap that some are predicting. He notes that $1.5 trillion worth of CMBS are set to expire between 2015 and 2018. If half of those were in trouble, it would leave $750 billion to be refinanced. If there was a funding gap of 20 percent on those maturing loans, that would leave a $150 billion gap—potentially “a gigantic opportunity,” according to Penner. “If it’s anywhere near that, then everyone’s going to have a very good time of it. And the returns will be pretty good.” But he believes the gap will be far smaller: “My sense, given what I saw in the last three or four years, would be that people would be somewhat disappointed.” While running funds for CBRE Capital Partners, Penner says the group redesigned its strategy late last decade to prepare for a predicted debt shortage, which he expected would create a need for the kind of capital CBRE raised. But the opportunity never materialized. “I don’t know why one would think that the next few years would be different than the last few,” he says. “I’m just so skeptical.” Penner’s preferred investment location is Europe. Prices are more conservative because less capital is chasing deals. “One can create a good relative value, a good risk-return profile there,” he says. Overall, Penner says the key to being a successful investor, both in real estate and in general, is to have a mandate broad enough to accommodate changing market conditions. Investment managers tend toward narrow mandates that could quickly be rendered obsolete. “It could be that for two and a half years they’re investing stupidly, not because they’re stupid but because the mandate [they executed on] has become stupid.” For LPs concerned about strategy drift, he says the solution is to find managers whom they trust to invest in a broad range of strategies, not just one real estate sector. “When I raised debt funds at CBRE, I made the case that you’re investing in me and my team and our acumen and understanding the business of real estate finance,” Penner says. “You’re not investing in our acumen to underwrite a sliver of that business but the totality of that business.