Q&A with PERE Credit: Relative value opportunities can reward disciplined lenders

The ground beneath the feet of both borrowers and lenders remains rocky. Inflation is still stubbornly high, and it's difficult to predict where rates will go. That's why Jessica Lee, chief investment officer of real estate credit at Manulife Investment Management, believes it's vital to remain focused on structuring loans and targeting the right assets that can withstand the challenges posed by macroeconomic volatility.

How liquid are the U.S. commercial real estate markets right now?

Commercial real estate credit has largely transitioned from a liquidity problem to a capital allocation problem.

Capital is available, but it isn’t evenly distributed, creating meaningful opportunities for disciplined lenders. At the same time, investors are navigating a wider range of possible outcomes for growth, inflation, and interest rates, which is increasing the importance of risk pricing and selectivity. From our perspective, that's why real estate credit has become a relative value business rather than simply a yield business.

More broadly, the market is searching for stability. In general, liquidity has significantly improved over the U.S. commercial real estate market for the past year or so because the public securitized markets, such as CMBS and CRE CLOs, have reopened. Private lenders and insurance companies have also been fairly active. Everyone is continuing to provide substantial amounts of capital.

However, while liquidity is there, it’s not evenly distributed across every property type, market, or borrower. I think it's less about whether capital exists and more about where it’s being allocated. It’s a question of risk pricing and which lenders – whether banks, insurance companies, debt funds, or public markets – are willing and able to provide financing solutions.

For disciplined lenders, those dislocations can create alpha through sourcing, structuring, and managing investments, generating attractive risk-adjusted returns that aren't dependent on a favorable interest rate or cap rate environment.

“Sponsors are increasingly valuing lenders that can tailor solutions to the specific circumstances of an investment and truly be their partners throughout the process.”

What roles can real estate debt have in investors’ portfolios?

Real estate debt has become important for investors because it combines downside protection with differentiated return drivers. The strategy complements private credit portfolios and broader real asset allocations because it's influenced by a different set of risks and market dynamics.

You don’t have to stop investing in something else to add real estate debt. It’s a natural diversifier because loans are secured by specific assets, providing transparency into the underlying collateral and risk profile. And even though the underlying market backdrop is fairly important when you’re lending on real estate, it’s less susceptible to what’s happening in the greater corporate market, where you’re influenced by different factors.

Like for corporate lending, it’s more about mergers and acquisitions and leveraged buyouts, whereas with real estate, it’s a complement in different cycles. Investors can take advantage of different market opportunities that are being created by participating across diverse products. It expands the opportunity set.

As investors look at risk management in their portfolios, real estate debt is influenced by different factors such as supply and demand in local markets and asset performance. But then, if they have exposure to corporate credit, it’s a different set of risk drivers. Corporate credit is tied to earnings and enterprise value, so it’s a complementary source of portfolio diversification and risk-adjusted return. 

What are borrowers looking for?

Ultimately, what borrowers are looking for is flexibility and customized solutions. And borrowers today are looking for financing solutions rather than simply maximizing loan proceeds.

Whether the objective is addressing a maturity, financing a business plan, or executing an asset recapitalization, I think sponsors are increasingly valuing lenders that can tailor solutions to the specific circumstances of an investment, truly be their partners throughout the process, and find the right alignment across both sides. 

How are you navigating borrowers seeking to refinance maturing loans in situations where the valuation has changed?

We’re seeing interest in very customized financing solutions and structures that understand evolving business plans. As a result, borrowers are seeking sophisticated lenders who understand not only credit risk, but also the underlying real estate and broader capital markets.

One advantage of operating within an integrated real estate equity and credit platform is that we can evaluate opportunities through both an owner’s lens and a lender’s lens, which often leads to a more complete understanding of value, business plan risk, asset-level fundamentals, and refinancing alternatives.

So, borrowers need flexible solutions, and this is what private lenders can generally provide. I think that combination is extremely important because the appropriate structure isn’t just determined by leverage or pricing; it has to account for the business plan's durability, and whether there are future funding requirements, as well as the potential range of exit and refinancing options that you’re evaluating.

How are loan structures changing? Are you seeing more complexity?

We’re assessing downside protection through various lenses, including the attachment point, cash flow, sponsor equity reserves, covenants, and control rights. It’s the combination of everything that can materially influence the resilience of a real estate credit investment. Our ability to draw on both equity and credit perspectives across the broader real estate platform also helps inform that assessment, particularly when evaluating asset-level risks, business plan durability, and value creation.

We want to provide flexibility to accommodate reasonable variability, but we're always looking to preserve protections for us, and for our investors. A big concern for lenders is when the performance of the borrower materially deviates from the original underwriting assumptions.

Institutional investors are looking for strong risk-adjusted returns, and one reason they invest in real estate debt is the natural downside protection it offers. So, as lenders, we're looking in many cases for opportunities to essentially create bespoke downside protections and negotiate for those structures when we're originating a loan. Those things are fairly important because it goes back to being able to distinguish risk that can be underwritten if you’re also making sure that you’re priced correctly for the risk you’re taking.

Risk has to relate to the leverage point. You have to look at the underwritten cash flow, capital requirements, and the competitive positioning of that asset you’re lending on versus the competitive set and sponsorship. All of these things go into what gives a deal strong risk-adjusted returns and making sure you’re paid correctly for the risks you’re taking.

“The best opportunities in real estate credit… emerge when capital markets become disconnected from underlying real estate fundamentals, and risk is priced inconsistently across lenders, borrowers, structures and markets.”

What is the impact of rate volatility on pricing and valuations?

From our perspective, we increasingly view real estate credit as a relative value business rather than just a simple yield business. One of my core beliefs is that the best opportunities in real estate credit rarely come from correctly forecasting interest rates, cap rates, or property values. They emerge when capital markets become disconnected from underlying real estate fundamentals, and risk is priced inconsistently across lenders, borrowers, structures, and markets.

There’s a lot of focus on interest rates, inflation, and what comes next for the economy. Of course, we’re paying attention to those factors, but rather than trying to predict the precise path of rates or the next macroeconomic outcome, we’re focused on identifying where volatility and uncertainty are creating those dislocations.

Lenders are becoming more selective. I think the bigger challenge isn't necessarily the absolute level of where interest rates are, but the uncertainty around where rates ultimately settle and how that influences valuations, financing costs, and capital flows.

From what we see, borrowers, lenders, and investors increasingly want greater stability because stable markets facilitate transactions, refinancing activity, and capital formation, while volatile markets can create pricing gaps and uncertainty.

Those periods of dislocation can create attractive opportunities because some of the most compelling investments arise when capital markets temporarily disconnect from underlying real estate value.

This material originally appeared on in PERE Credit and is repurposed with permission. The views expressed are subject to change. Manulife Investment Management is not responsible for the comments by or views of anyone not affiliated with Manulife Investment Management.