Grant's Current Yield Podcast – Episode Summary

Episode: THE NEXT MELTDOWN
Date: August 6, 2024
Host: Jim Grant
Guest: Richard Byrne (President, Benefit Street Partners)
Co-host: Evan Lorenz

Episode Overview

In this episode, Jim Grant and Evan Lorenz are joined by Richard Byrne, president of Benefit Street Partners, to discuss the state of the credit cycle, the looming threats facing commercial real estate—especially the office sector—the evolving investment landscape, and the implications for regional banks. With characteristic wit and deep historical context, the conversation investigates where the real estate market stands, what opportunities and risks are lurking, and how investors might navigate turbulent waters ahead.

Key Discussion Points and Insights

1. The Return of Volatility and the Political Environment

• Jim Grant notes the revived market volatility as the 2024 U.S. election season heats up:
  • “Donald Trump is the avatar of volatility and ... we are in for a great few years of journalism come what may.” (01:13, Grant)

2. What Is a Credit Cycle?

• Richard Byrne reflects on four decades of credit cycles:
  • The next crisis is rarely the one people are anticipating.
  • "The punch he didn't see is usually the one that knocks you out." (03:14, Byrne)
  • Past crises (dot-com, GFC, COVID) largely went unseen by most experts.

3. Today's Big Problem: Commercial Real Estate and Offices

• “The thing it is now is commercial real estate.” (04:52, Byrne)
• Interest rates have caused values to drop across asset classes—real estate values are mathematically down ~20–25%.
• Office properties are particularly troubled:
  • Class B/C offices are at risk of becoming effectively worthless, with underlying values down by 50%+.
• Leverage compounding risk: Most real estate investors, lenders included, are heavily leveraged.
• Major Loan Maturity Wall: $1.7 trillion in CRE loans mature over the next 2–3 years.

4. Where Are the Investment Opportunities?

• Byrne describes a “double-edged sword”:
  • Legacy books (existing loans) are mired in problems.
  • Huge opportunity arises for “new money” in fresh lending amid distress.
    • Three main avenues:
      1. Buy distressed assets when banks “puke” loans—opportunities arise but timing unpredictable.
      2. Provide ‘gap financing’ (mezzanine or rescue loans to bridge maturities).
      3. Make new loans as others retreat—particularly in multifamily, at much more conservative loan-to-value ratios.
  • Quote: "We're getting invited into rooms these days that we never were invited to for really nice deals." (12:16, Byrne)

5. Specific Numbers on Returns and Lending

• Typical new multifamily loans: SOFR + 300bps, i.e., unlevered high-single-digit yields (~8%), potentially higher with leverage. (12:31–13:03)
• The risk-adjusted opportunity for lending today exceeds returns in most credit or equity corners.
• Quote: “You’re generating your return as current income; you don’t have to bet on anything good happening.” (19:56, Byrne)

6. Multifamily vs. Office – The Bull and the Bear

• Sunbelt multi-family remains a borrower favorite—demographics and supply dynamics favorable:
  • Temporary pressures from new supply and increased operating costs expected to abate as little to no new supply is in the pipeline.
  • Singles’ inability to afford homes boosts rental demand.
  • Liquidity remains courtesy of Freddie Mac and Fannie Mae.
• Office, by contrast, faces a “three- to five-year” reckoning as rent rolls and tenants gradually adjust to new workplace norms.
  • Landlords face a “prisoner’s dilemma” to retain tenants through subsidized packages.
  • “Office is going to be the 90/10 rule here. The timing will be determined by…when is the office sector right itself?…three or four to five years from now.” (21:06, Byrne)

7. Public vs. Private Market Strategies for Investors

• Valuation disconnects: Many public REITs trade at a deep discount to asset values (up to 30% below book).
• Long-term equity investors might see this as a buying opportunity, but income-focused investors may find safer, more attractive returns in new lending strategies.
• Most lending funds are not public and require due diligence; the public options are mainly equity not credit.
  • Grant: "Where does that individual go to get that [8% yield]?"
  • Byrne: “You want to invest in a new money lending portfolio ... that's putting out money today... We're working on it.” (23:08–23:54)

8. Potential Regional Bank Fallout

• Roughly half of commercial real estate loans are held by banks, with small regional banks holding about one-third of all CRE loans.
• Regional banks are less diversified, more exposed to suburban/low-quality office, and may face protracted pain.
• Quote: “They're going to be hurting for a while from this real estate exposure.” (26:17, Byrne)

9. The Future of Unoccupied Offices

• Many obsolete office properties will ultimately be demolished or repurposed, with some land becoming “parking lots.”
• Conversion ideas (office to multifamily/condo): More hype than scalable solution because of high capital cost.
• Quote: “Parks, parking lots ... office will be a really attractive investment in a couple of years for well-capitalized buyers ... it just seems too early right now.” (27:38, Byrne)

Notable Quotes & Memorable Moments

• On volatility: "Donald Trump is the avatar of volatility and ... I am grateful for many things and not least journalism." (01:13, Grant)
• On unexpected crises: "The punch he didn't see is usually the one that knocks you out." (03:14, Byrne)
• On office: “Office is a bigger problem than I think people are letting on.” (04:57, Byrne)
• On distressed office loans: “Put a 50 or 40 on 25% of your portfolio and the rest of it's down also...” (06:31, Byrne)
• On yield opportunities: “We're generating unlevered high single digit return on current income on a loan.” (13:01, Byrne)
• On the drawn-out pain: “It’s going to take time ... three or four to five years from now.” (21:06, Byrne)
• On regional banks: “They're going to be hurting for a while from this real estate exposure.” (26:17, Byrne)
• On obsolete offices: "Parks, parking lots ... that's the opportunity. It just seems too early right now." (27:38, Byrne)

Timeline of Important Segments

• 00:00–03:14: Introduction; credit cycle basics; unpredictability of crisis
• 03:14–08:20: Current cycle focus; deep dive into commercial real estate, especially office
• 08:20–13:51: Investment opportunities, loan market dynamics, yields
• 13:51–16:55: Multifamily sector, Sunbelt, operating expenses, housing supply/demand
• 16:55–20:44: Navigating public/private investment options for individuals
• 20:44–23:56: Distress cycle progression; where are we in write-downs; sodium pentothal analogy
• 23:56–26:17: Recession, labor, and office demand
• 26:17–28:22: Regional bank exposure; fate of obsolete office buildings

Takeaways for Listeners

• The next meltdown is likely somewhere few expect—this time centered on commercial real estate, especially the office market, with heavy repercussions for regional banks.
• The silver lining is for new capital: fresh lending offers unusually attractive, risk-adjusted returns in high-quality, non-office sectors.
• Investors seeking yield should eye “new money” lending vehicles, but most public options focus on property equity, not debt.
• The shakeout in offices will be slow; expect several years of pain and eventual conversion for select assets, but the timing is not yet optimal.
• Regional banks remain deeply exposed, and further fallout is likely as loan maturities and asset writedowns accelerate.

For those not listening:
This episode provides a clear-eyed tour of CRE’s troubles and where savvy investors should search for returns, using history, humor, and hard numbers to untangle one of finance’s knottiest problems of 2024.