Commercial Real Estate: 2025 Outlook

Could you introduce yourself and Voya and explain its ethos around commercial real estate investing?

I've been with Voya for 30 years, which is before it was called Voya—we used to be part of ING Group, the Dutch bank life insurance company. We ran proprietary real estate in the Americas. After the global financial crisis, Voya spun off ING USA in an IPO and became Voya. 

My commercial mortgage lending program has been around for over 80 years with the insurance companies it was attached to. We manage $16 billion.¹ Approximately $5 billion of that is for Voya, and the rest is third party.  
This represents pretty big growth since we left ING. Back then, we were $12 billion in proprietary assets. Now, we're $16 billion in AUM, with $5 billion in proprietary assets. Since we went public, we've been able to pivot from being a proprietary manager to a third-party manager without a hitch.  

That $11 billion in third-party assets breaks down into separate accounts and an open-ended debt fund. On the separate account side, we manage 28 SMAs. Obviously, insurance companies are well represented, including P&C, workers comp, and life insurance. We also have several private pension funds, and one industrial bank. Our open-ended debt fund has 27 investors, most of whom are insurance companies.  

We only do mortgage loans. We loan throughout the capital stack, however, from conservative up to things that are almost equity-like—in our business it’s called core, core plus, and opportunistic. The definitions for real estate lending get a little complicated, and vary from company to company, but for us, the core is the basic, low-leverage deals, NAIC 1 or 2, the equivalent of investment grade. Our core plus tends to be light transitional bridge deals, NAIC 2 to 3. And the opportunistic is the higher-leverage bridge, preferred equity construction loans and participating mortgages. 

Given the moves in interest rates and changes in commercial real estate valuations over the last few years, how are you managing the existing portfolio? What are you seeing in your current cycle? And what do you think is the best strategy around that?

The interest rates have definitely affected our existing portfolio, but they’ve also impacted our origination, because origination is going to be geared off investment sales, and investment sales had slowed down when interest rates started moving up for a variety of reasons.

The main reason is cap rate spreads were moving around. Cap rates don't move in step with interest rates; they are much less volatile, so property investors can experience a lot of spread compression or expansion if the 10-year treasury yield bounces around like it has been. This slowed down a lot of investment sales slowed down because people could not get clear on prices. They couldn’t figure out where the cap rates would be, and so many investors sat on the sidelines until the Fed moved into a cutting cycle and everything calmed down.

Now, the Fed has lowered interest rates by 100 bp, but we saw the 10-year Treasury yield move in the opposite direction—up 90 bp from September’s first cut to the end of January. The Fed doesn’t have the ability to move the long end of the yield curve, but what we are seeing is more stability in rates. And with that stability, we've seen a pickup in investment sales, and therefore we’ve seen a pickup in our loan production.

That's how interest rate uncertainty affects origination. Where it hits the existing portfolio is in the floating rate side, which has been stressed with interest rates going up. The fixed-rate portfolio is not as impacted, unless you get to a maturity date.  

Even though rates have backed off from the significant increases of 2022, it’s still caused us to spend a lot of time with our asset management team, because at the same time those interest rates went up, a lot of property owners’ other expenses went up too. That equates to stress on debt coverage ratios.

“What separates a successful commercial mortgage asset manager from a less successful one is being proactive with management of their portfolio.”

We’ve got a great, decent-sized asset management team, split into regular management and what we call ‘special situations.’ Special situations are like real estate owned properties (REOs), which is where the lender owns the property, or deals where we've seen the interest rate cap is about to expire and the borrower is not willing to get a new one. We have to figure out how to move forward with the property. We try to avoid that, which is why we have a group that is hyper-focused on properties where there could be stress.

The asset management team also monitors all the core plus (bridge) loans, just to see if the business plans are moving along—if not, the loan may need to go to our special situations team.  

In times like the past couple years, given the same portfolio, what separates a successful commercial mortgage asset manager from a less successful one is being proactive with management of that portfolio. We want to stay ahead of any issues. We don't want anything to fester because typically, multi-family borrowers are going to own multiple assets. You want to make sure that they focus on your asset, that the capital is going to your asset, and not going to some other lender’s asset. You can only accomplish that by being proactive. 

Are there certain risks in the current environment that are being underappreciated by the market?

Yes. There's a shortage of housing right now in the U.S., and housing affordability is also tight. The new administration's policies may have some unintended consequences regarding housing that many investors are not considering.  That’s something that we're thinking about as we look at our multi-housing lending operation, and we look at build-to-rent single-family rentals.

“There’s a shortage of housing right now, and affordability is also tight.”

Do you believe we've had a trough in office valuations?

It's interesting. I'll go back to the new administration; the government says, you have to go back five days a week to the week and JP Morgan says that and the big financial institutions say employees should go back to five days a week. Now, are the markets going to go to five days a week for all different industries? Probably not, but you are seeing a rollback into being in the office at least three days a week.

Whether you’re in the office two-three days a week or five days a week, you’re using the same amount of office space. That concept bandied about after the lockdown ended of ‘some of the team will be in this part of the week and the rest will be in a different part of the week’ and making people share is just not happening. To me, this means the amount of office space is not going to get reduced any further than what we've seen.  

The other thing that we see in the market is there's less and less remote work available on the job boards. It has been reduced dramatically. What does that mean? We’re not going to add a lot of big office space, but I don't think it reduces it. So, are we at the trough? Difficult to say, but, if not, then we're pretty close to the trough, because demand has stabilised.

We’ve also seen that resi conversion is not the panacea some investors thought it would be during the pandemic. It works only in some markets. It’s not going to work in New York City, but there are suburban properties that could be easily converted—and that helps.  

“I do think we’ve hit the bottom with office, but it’s going to be a long, flat bottom.”

We just saw a recent deal for an office complex that had five office buildings. Three of the office buildings have been taken offline—they were converted to resi. You had five office buildings, now you're down to two. That helps the supply-demand dynamics. We have, in some cases, seen deals where they didn't convert the office building, but instead tore it down and built apartments there. That also works.  

Based on these factors, I do think we've hit the bottom, but that bottom is going to be shaped like a canoe: It's going to be a long flat bottom. I don't think you're going to see a big bounce back in the near future, but also I don't think we're going to see many more major across-the-board declines in valuations.

Where do you see the best opportunities in the market today, both in property types and in the capital stack?

I go back to the U.S. housing shortage that I touched on earlier. Where the opportunity is there is not just standard multi-family properties. We’re also considering build-to-rent (BTR), single-family rentals (SFR), etc. We're even looking at residential fix and flip (RTL). So, when we say we want to lend on multi-family, it's not just apartment buildings, it's the whole concept of places for people to live.

We're looking at these areas as a concept set, isolating it off from apartments. You have to do that, because when you look at apartments in some markets, you also have to figure out how single-family rental and build-to-rent are impacting that market. You can’t just look at sale or rent comps on multi-family alone, you must also look at the BTR and SFR markets.  

In general, though, we think there is opportunity in living spaces, but you have to look at them holistically as an asset class. That's how you're going to make the best real estate decisions: By looking at all forms of rental living spaces together and not just isolating build to rent or single family or multi-family.

“You've got to adjust your investment thesis to make sure you're mirroring how the tenant views the market.”

You want to combine those concepts because renters themselves combine them. A renter is going to look at multi-family in their area, but they’re also going to look at build-to-rent, they're going to look at single-family rentals, and pick what they like best—and because of that dynamic, you've got to adjust your investment thesis to make sure you're mirroring how the tenant views the market.

With the changes, what do you expect lending volumes to be in 2025 especially as commercial real estate recovers? 

The stabilisation of interest rates is going to open up things a little bit more. You're going to see more sales this year, which then will equate to more loan volume.

The other thing to remember is that developers only make money by selling assets. They don’t make money from rent, they make it by selling properties. A lot of developers have been sitting on assets that they have been able to sell, so there's going to be natural pressure for them to get off the sidelines now that rates and prices seem to be stabilizing.  

“Some developers haven’t sold a property in a couple of years, and now they’re feeling some pressure.”

Some of these developers haven’t sold a property in a couple of years., and now they’re feeling some pressure where they’re forced to say, “I was holding out for a 15% IRR, but I might have to take that 10-11% IRR, because my investors want their money back and I’ve been holding them off.” As those properties hit the market, buyers will take loans out to buy them, and that’s more potential volume for us right there.  

All this means there’s going to be more demand for credit. We’re already seeing lenders re-enter the market. You had some lenders pull out of the market, but others are starting to replace them. We’re seeing quotes get much more competitive than they were last year, which means that there's more money in the market chasing deals now.

Where do you see opportunities? And does Voya have a specific competitive advantage in the market?

We like operating in secondary markets for the most part. Markets in real estate terms break down into primary, secondary, and tertiary. If you take the list of Metropolitan Statistical Areas (MSAs), which are the political areas, we operate in the top 50. The top seven are the primary markets: New York City, Chicago, Los Angeles, San Francisco, Boston, Washington DC, and Miami. Then the rest of the top 50 MSAs are the secondary markets. For example, the 50th MSA is Buffalo, New York.

The secondary markets that we like a lot are the high-growth ones: Charlotte, North Carolina; Salt Lake City, Denver, places like that. We look at the tertiary markets outside the top 50, too. For example, I’d prefer to look at properties in a tertiary market like Albuquerque than a secondary one like Buffalo, because Albuquerque’s growth dynamics are much better.

“We specialize in secondary markets because of their growth potential. It’s an area a lot of investors overlook, which is just leaving money on the table.”

We've specialised in those secondary markets because of their growth potential. This is an area that a lot of investors traditionally overlooked, which to me was just leaving money on the table. For the longest time, a lot of foreign investors and large investors have said they don't want to be in these secondary markets because they don’t think there's enough liquidity.

Then, during COVID, it became bad to be in primary markets. Lenders who typically wouldn’t touch a secondary market started to come in. We call them tourists. These were all lenders who for years had said, “No, we only like the big markets,” and all of a sudden they started flooding into the secondary markets.

And while I salute lenders having the self-awareness to shift their investment thesis when challenged, it was a really interesting dynamic to observe. We've been in these secondary markets for decades, and my team knows what's cheap and what's not cheap in them because we have data going back more than 20-odd years.

But when you have someone that's been focused on the primary markets, and they suddenly parachute in to, say, Atlanta, everything looks cheap compared to New York City. You can see the problems likely to occur, can’t you.  

That's where we have a competitive advantage. We’ve always liked secondary markets and operated in them, and we understand them in a way that tourists don’t. Ask your CML partner where they operate. They’ll say they lend everywhere, but that’s usually marketing bunkum. They should be able to show you a map of where their loans are.

It’s also about commitment to secondary markets. When market volumes come back, if you're an investor that tries to lend $3-4 billion or more a year, at some point you’re going to go back to the primary markets. 

Deep secondary market expertise is where we think Voya’s competitive advantage is. I'm not saying the primary markets are bad places; we do some work in primary markets. But I believe our alpha is added in the secondary markets.

Lastly, ‘office’ is a four-letter word at the moment but at some point, there's going to be an entry point in office that's going to make sense. There's going to be money to be made. Maybe not in 2025 but in 2026 or 2027 there's going to be money to be made.

Apartments are also struggling, but unlike office, multi-family has a natural bottom, because Fannie Mae and Freddie Mac fund them. Multi-family is going to have another rough year in 2025, but that also presents a lot of opportunistic potential for us.

 “Hospitality is the next area to get hit, and possibly the next opportunity.”

In my view, hospitality is the next area to get hit, and possibly the next opportunity. Hospitality hung on so long because during COVID, hotels were able to postpone Property Improvement Plans (PIPs), which cover putting in new soft goods, new TVs, certain signage, etc. Because the franchisors (the flags) saw that hotel owners used a lot of their money during COVID to float these hotels, the flags were generous with not making them adhere to new PIP standards. Now the flags are asking for changes and that's going to create a lot of stress in the hospitality market. There was a good article recently about how Westin wanted franchisees to put new signage out. The signs were going to cost these owners a lot of money but were unlikely to create any new revenue. You’re going to see more tension between the flag and hotel owners as 2025 goes on.