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CRE Finance World Winter 2016
40
You could say the same thing though about any stock that misses
big on earnings. Look at Chipotle, the thing dropped like 18
—
this
is a multibillion dollar company and it drops 18% in five minutes
because of one little statement.
People like to pretend that they live in a continuous world and
that financial asset prices move in a continuous way, but we live
in a highly discontinuous world, and the financial asset prices are
discontinuous. In the mid-00s, people were spoiled by an absurd
level of liquidity in the bond market, which we’ll probably never
see again.
Stephen Renna: Interesting. Thank you. I did want to ask your
view on investing in real estate debt versus other fixed income
opportunities. What you think about that?
Jeffrey Gundlach:
If you’re going to invest in credit in the bond
market, for sure you should be in real estate credit. Furthermore, you
should be invested in real estate credit to a much greater extent than
in corporate credit or emerging market credit because the evils that
are plaguing the credit markets are commodity price-related and
deflation-related and mostly in materials and productive commodities.
Real estate has experienced zero deflation in the past several
years. If commodity prices stay where they are — forget about
going lower — if they just stay where they are, that would mean a
forward calendar of rising corporate defaults. That’s what the junk
bond market is telling you, that’s what the loan market is telling
you, that’s what emerging markets are telling you. It’s one thing if
oil goes from 100 to 40 to 80; it’s another if oil goes from 100 to
40 to 40 to 40 to 40 because 40 is a money-losing level for a lot
of companies.
They’re playing beat the clock: “How long can I wait this thing
out?” You can’t blame these companies, hedging costs a lot of
money. To hedge your book back in 2013 against $40 oil cost
a fortune, and understandably nobody hedges out for 10 years.
We’re now in year two of oil being really low, and if it stays at these
prices into year three, so 12 months from now, the defaults will
be inevitable and on the rise — a scenario that’s going to cause
distress in the system.
However, in mortgage real estate debt, if it’s residential mortgages,
it’s all good. The home prices have gone up, the lower commodity
prices put a small amount of money into the homeowner’s pockets,
so they’re more likely to make their mortgage payments.
Commercial real estate has benefitted from the growth in rental
units, which have been in very high demand. There’s been a lot
of pricing power on rents, which is unfortunate for the renter but
pretty good for the operators of commercial real estate.
CMBS is really remarkable for the yield spread available by credit
quality. BBB rated CMBS, the lowest tier investment grade, yields
7.5% to 8% today. For a 10-year security, that’s unbelievably high
versus what you have in a basket of BBB rated corporate bonds in
the 10-year category.
Despite the much higher yield, I would argue that the CMBS market
entails less the risk. You’re capturing more yield with less risk
because the risk variable of low commodity prices is far less of an
issue in the CMBS market. The CMBS market is on its lows. It’s
nowhere near as weak in recent weeks as the junk bond market,
but it’s on its wide spreads simply because of supply. There’s been
a lot of supply. Of course, the year is coming to end, so that’s going
to dissipate. The beautiful thing about CMBS really is that here
we went through a large-volume market issued in ‘06 and ‘07 that
suffered through the Great Recession, suffered through a banking
crisis, and yet it survived pretty well.
There were white knuckle moments for sure in that market because
it was a highly stressful environment. And the market pricing and
the market structuring continues, not surprisingly, to have bad
memories of the fears that were prevalent six or eight years ago.
Subordination levels have increased and underwriting is a little
bit better than it was, and yet the default rate through that crisis
wasn’t that bad. So we’ve been viewing CMBS as one of the best
opportunities in the fixed income market. Where you’re able to pick
up credit spread but it in a way that sidesteps the major issues
facing the credit market.
We kind of call securitized bond investing, “hard assets for hard
times.” It’s hard times in the manufacturing sector, it’s in a recession.
It’s hard times for the commodity producers, but we have hard
assets underneath residential and commercial mortgage-backed
securities, and yet the hard times don’t really affect them so much.
The residential real estate category has seen little new issuance,
but there’s still $700 billion of legacy securities. That highly
seasoned market is utterly immune, I think, to the problems in
the world today because the fundamentals have been improving
for the underlying credits as opposed to deteriorating.
CREFC Exclusive Interview with Jeffrey Gundlach