Transitional Lending – The Sweet Spot in CRE Investing

The mortgage relies heavily on recent historical performance to make long-term forecasts. In commercial real estate (“CRE”), we believe this habitually manifests itself in underpricing the risk of an occupied building becoming vacant and overpricing the risk of a vacant building remaining vacant. In other words, the market assumes that stabilized fully occupied properties remain stable forever and non-stabilized vacant properties have only a small chance to improve although data suggest otherwise. This paper examines the risk-reward associated with investing in stabilized/non-stabilized CRE, and argues that low leverage loans backed by transitional properties may be the sweet spot for CRE investing in the current environment. Throughout the paper, we use analysis and data from the largest traditional CRE sectors (such as offices, retail, and industrial). That said, data suggest that the results are similar for other sectors and for the broader CRE market as a whole.