Goldman Sachs AM: Debt markets are reaching inflection point

Inflation, supply/demand imbalances and the war in Ukraine are making their impact felt while investors shift capital out of public markets, say Richard Spencer, Lee Levy and Andrew White, senior real estate credit investors at Goldman Sachs Asset Management.

This article is sponsored by Goldman Sachs Asset Management.

Goldman Sachs started investing in private real estate in 1991 and is one of the longest-standing investors in the market. Today, the Goldman Sachs Asset Management Real Estate platform consists of more than 300 dedicated real estate professionals across 18 cities and 12 countries. Collectively, this team has originated more than $17 billion of senior and mezzanine real estate loans globally since 2008.

Let’s start with an overview of the debt markets. Where are we right now?

Richard Spencer, Goldman Sachs Asset Management

Richard Spencer: Prior to covid-19, we saw traditional lenders start to flood into sectors like housing and logistics given broader recognition of yield benefits in these sectors. At the same time, we saw foreign capital move into mezzanine debt strategies, which generally resulted in deterioration in yields and terms.

These trends generally continued into covid, although the depth of capital in larger, complex situations, including development, is still more limited given these are areas where traditional lenders are not active and where public market solutions cannot provide the sort of execution certainty that borrowers need. These situations have created opportunities for private lenders to step into this void. This story has played out across the US and Europe, as well as parts of Asia, and heighted development activity across private real estate markets has further fuelled this opportunity set.

We are now at what we think could be another inflection point in the capital markets, with higher inflation, supply/demand imbalances, trade tensions and global pressures arising from the Russia-Ukraine conflict. These factors and volatility in public markets have impacted investor sentiment and capital availability in recent months. At the same time, investors feel increased pressure to shift capital out of the public markets in a rising rate environment.

What trends in credit do you see in a rising rate environment?

Andrew White, Goldman Sachs Asset Management

Andrew White: It is a really interesting time right now and a period that we have not seen in quite some time in terms of projected interest rate growth over the next two years. In a rising rate environment, floating-rate lenders have the ability to benefit from a rise in benchmark rates, as well as from rental growth in underlying assets.

At the same time, they can mitigate risks by requiring borrowers to hedge their interest rate exposure and by focusing on assets and sectors that are more likely to benefit from continued tenant and capital markets demand.

In this environment, lenders benefit from downside protection, particularly where there is significant equity subordination. To the extent asset values do come under pressure as a result of rising cap rates or deterioration in overall demand, lenders stand to benefit.

Why do borrowers come to groups like Goldman?

RS: There are a number of factors. We have been active in this alternative lending universe since the global financial crisis. We have been a solutions provider to some of the largest real estate private equity sponsors and developers. With our service and certainty of execution, we are seeing repeat business – more than 60 percent of our loans have been with somebody who has borrowed from us more than once.

We have an integrated platform across real estate equity and real estate credit with a single global investment committee. We have in-house construction, asset management and ESG specialists. We can call on all of those groups to source and execute transactions and, as a result, we can provide speed and certainty of execution to our sponsors. Our sponsors are typically looking to capitalise larger, more complex projects that need certainty and speed of execution. Since the start of the pandemic, there has been more volatility and more uncertainty in the world, and our borrowers have reached out to us to help them navigate this period.

We hold these loans to their full maturity and do not syndicate or securitise anything. We think it is important to control our own investments and our borrowers know if they need to make an amendment or modification to a loan during its life, they are calling someone at Goldman, not a servicer or syndication agent.

Finally, I believe we are coming to these investments with an equity investor mindset and are speaking the right language. If a borrower needs a certain amount of flexibility on a loan, we understand why and we are creative enough to structure the deal in a way that protects our interests and gives the borrower a bespoke structure that fits what they need.

Can you talk about construction and tenants’ flight to asset quality?

Lee Levy of Goldman Sachs Asset Management
Lee Levy, Goldman Sachs Asset Management

Lee Levy: Richard mentioned construction lending as an area where we continue to see less competition among lenders. This was an observation that we initially made in equity markets, given that we were very active developers, particularly in the US, coming out of the financial crisis. We are focused on lending to institutional sponsors in markets with strong supply/demand dynamics. New construction is an area where we see both value and resiliency.

Over the last decade, we have been very large developers of multifamily, industrial, office and, to some extent, hotels. What we saw from those assets as they were delivering was a flight to quality from tenants who were setting record rental rates and record pricing on exit. At the same time, we also noticed that the financing markets were inefficient for construction financing.

How important is green lending to the business, within Goldman and for your borrowers? Is this becoming more important in the US?

AW: As Lee mentioned earlier, we are financing the construction of sustainable assets, which is critical to our firm, our borrowers, the tenants and this ultimately helps to underpin the value of the real estate. ESG is becoming more important in all of our markets, for borrowers, lenders and the rest of the market. There are a couple of reasons for that. The ESG agenda for a firm like ours is increasing in importance and we are focusing on the environmental, social and governance elements. We now have a due diligence questionnaire for every new asset, finding out things such as, where applicable, its energy efficiency, use of recycled material, the social features and about the sponsors themselves for the governance component.

We are also seeing a flight to quality and sustainability among tenants and property owners, whether it’s energy efficiency, the use of materials or the social impact.

Richard Spencer is a partner at Goldman Sachs Real Estate Asset Management based in London; Andrew White is a managing director at Goldman Sachs Real Estate Asset Management based in Dallas; Lee Levy is a managing director at Goldman Sachs Real Estate Asset Management based in New York