Ares Commercial Real Estate Corp
NYSE:ACRE
Earnings Call Analysis
Q4-2023 Analysis
Ares Commercial Real Estate Corp
Ares Commercial Real Estate Corporation faced a challenging economic environment in the fourth quarter of 2023. Simultaneously confronting higher interest rates, inflation, and cultural trends like remote work, the resulting stress was particularly evident in many office properties, leading to a GAAP loss of $0.73 per common share for the quarter. The management stressed their strategy focusing on resolving non-performing loans (9 categorized risk-rated 4 or 5 loans) and improving problematic areas within their $1.6 billion portfolio, primarily composed of senior first lien loans predominantly collateralized by multifamily, industrial, and self-storage properties.
In the face of these difficulties, Ares announced proactive measures taken to address their outstanding loans, including the successful sale of a significant senior loan. They are also in progress to dispose of an office property in Illinois and to restructure other loans. A regular dividend payout was maintained at $0.25 per share for the first quarter of 2024, reflecting both an acknowledgment of past challenges and confidence in future plans. Despite the current difficulties and GAAP net loss for the year, they emphasize their strong liquidity, evidenced by significant cash and undrawn credit facilities, and a sustainable net debt to equity ratio of 1.9x. This should help them manage their current loan portfolio challenges.
Company executives pointed out that their sizable reserves, amounting to 28% of the outstanding principal balance of higher-risk loans, alongside their diversified financing strategies and absence of mark-to-market provisions, provide a stable foundation to address the current pressures. Executives conveyed cautious optimism about the future, with resolutions in place to recover lost earnings from the problematic fourth quarter. The guidance was set for improving distributable earnings in the near term and potential recovery to higher levels of earnings, hinting at procedural improvements, strategic loan restructuring, and leveraging the market know-how within the Ares Real Estate Group.
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Good morning. Welcome to Ares Commercial Real Estate Corporation's Fourth Quarter and Year-end December 31, 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Thursday, February 22, 2024. I will now turn the call over to Mr. John Stilmar, Partner of Public Markets Investor Relations.
Good morning, and thank you for joining us on today's conference call. I'm joined today by our CEO, Bryan Donohoe; our CFO, Tae-Sik Yoon; and other members of the management team. In addition to our press release and the 10-K that we filed with the SEC, we have posted an earnings presentation under the Investor Resources section of our website at www.arescre.com. Before we begin, I will remind everyone that comments made during the course of this conference call and webcast, as well as accompanying documents, contain forward-looking statements that are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as participates, believes, expects, intend, will, should, may and similar such expressions. These forward-looking statements are based on management's current expectations of market conditions and management's judgment. These statements are not guarantees of future performance, condition or results and involve a number of risks and uncertainties. The company's actual results could differ materially from those expressed in the forward-looking statements as a result of a number of factors, including those listed in its SEC filings. Ares Commercial Real Estate assumes no obligation to update any such forward-looking comments. During this conference call, we'll refer to certain non-GAAP financial measures. We use these as measures of operating performance. These measures should not be considered in isolation from, or a substitute for, measures prepared in accordance with Generally Accepted Accounting Principles. These measures may not be comparable to like-titled measure used by other companies. Now I'd like to turn the call over to our CEO, Bryan Donohoe. Bryan?
Thanks, John. Good morning, everyone, and thank you for joining our fourth quarter 2023 earnings call. As I'm sure you're aware, we continue to see higher interest rates, higher rates of inflation, as well as certain cultural shifts such as work-from-home trends adversely impacting the operating performance and the economic values of commercial real estate. This is particularly evident [through] many office properties. In addition, many properties requiring significant capital expenditures have been impacted by higher labor and material costs. Unfortunately, we are not immune to these macroeconomic challenges, and our results for 2023 and the fourth quarter are partially a reflection of these conditions. For the fourth quarter, we had a GAAP loss of $0.73 per common share, driven by a $47 million, or $0.87 per common share increase in our CECL reserve, most of which is related to loans collateralized by office properties or residential condominium construction projects. In addition, for the fourth quarter, we placed 6 additional loans on nonaccrual status, which impacted both our GAAP and distributable earnings by approximately $0.12 per common share versus what these 6 loans contributed in the third quarter of 2023. As a result, our distributable earnings for the fourth quarter were $0.20 per common share. Fortunately, we are starting to see some positive trends in the macroeconomic environment that we believe are likely to benefit commercial real estate, including the potential for declining short-term interest rates. Specifically, declining spreads on CMBS and CRE CLOs, particularly during the past 6 months, reflect strengthened capital markets conditions. Positive leasing momentum in certain sectors, including industrial and self-storage and continued healthy demand trends for multifamily assets underscores some of the opportunities we see in today's market. These trends play out across our portfolio, particularly for loans that are risk-rated 1 to 3, which total about $1.6 billion in outstanding principal balance. This risk-rated 1 through 3 portfolio is focused on senior first lien positions and is diversified across 37 loans. The majority of these loans are collateralized by multifamily, industrial and self-storage properties, with the largest focus on multifamily properties at 34%. As a positive indication of borrowers' commitment to the properties, they contributed more than $150 million of capital, representing about 10% of the $1.6 billion and principal balance of these loans. A portion of this $150 million was used to renew all interest rate caps that expired in 2023 at their prior strike rate or at an economically equivalent amount after considering additional reserves. Let's now turn to our strategic plans to resolve the 9 remaining risk-rated 4 or 5 loans that comprised about $539 million in outstanding principal balance and 1 loan held for sale with a carrying value of $39 million as of year-end 2023. As we mentioned, these loans are primarily collateralized by office properties and 1 residential condo property. First, we will fully leverage the management capabilities of the Ares Real Estate Group. As we have discussed previously, Ares Real Estate Group has more than 250 investment professionals and currently manages more than 500 investments globally, totaling approximately $50 billion in assets under management. We intend to use these capabilities to resolve underperforming loans held by ACRE. Second, we have built significant loss reserves against these 4 and 5 risk-rated loans. As of December 31, 2023, 91% of our total $163 million in CECL reserves, or $149 million, is related to these 9 loans, which is about 28% of the $539 million in outstanding principal balance for these loans. Finally, we have been highly purposeful in positioning our balance sheet over the past few years to provide us with greater flexibility and time to resolve these underperforming levels. For example, our net debt to equity has declined from 2.6x at year-end 2021 to 1.9x at year-end 2023, in both cases for the impact of CECL reserves on our shareholder equity. In addition, we have accumulated additional available capital, which totaled $185 million. All of these measures and capabilities have positioned us to work through our underperforming REIT loans while balancing the goals of maximizing proceeds and accelerating the timeframe for resolution. So far, we have made some notable progress towards these goals. First, at the end of January 2024, we successfully sold the $39 million senior loan held for sale at a price equal to its year-end 2023 carrying value. Second, although we do not close on the sale of the office property in Illinois that backed our $57 million senior loan before year-end 2023, our borrower is under an agreement to sell the underlying property in the coming weeks. Third, we are working diligently to resolve 3 additional loans in the next few months. One loan will likely be resolved through the sale of the underlying property. The other 2 may involve restructuring terms of the loan so that we can return a significant portion of the principal balance to accrual status, including having the borrower contribute additional capital to the properties. Now let me provide some additional background on our dividend of $0.25 per share that our Board of Directors has declared for the first quarter of 2024. Since our Initial Public Offering nearly 12 years ago, we have operated with a framework that considers our distributable earnings power when setting the quarterly dividend. Up until this time, we have not reduced or delayed our quarterly dividend. In fact, we provided $0.02 per share in supplemental dividends for 10 quarters. In this current market environment, however, we believe it is in the best interest of ACRE and its stakeholders to reduce the quarterly dividend to help preserve book value and liquidity and to pay out an amount more in line with our expected near-term quarterly distributable earnings before realized losses. Ultimately, as we get through this cycle, (indiscernible) we execute on our earnings opportunities as discussed, we expect we can return to higher levels of profitability. With that, let me turn the call over to Tae-Sik.
Thank you, Bryan, and good morning, everyone. For the fourth quarter of 2023, we reported a GAAP net loss of $39.4 million, or $0.73 per common share. As Bryan mentioned, our GAAP net income was adversely impacted by a $47.5 million increase in our CECL provision, or about $0.87 per common share. For full-year 2023, we reported a GAAP net loss of $38.9 million, or $0.72 per common share, and distributable earnings of $58.4 million, or $1.06 per common share. Our book value per common share now stands at $11.56, or $14.57, excluding a $3.01 per share CECL reserves. Distributable earnings for the fourth quarter of 2023 was $10.8 million, or $0.20 per common share, which was adversely impacted by the 6 additional loans that were placed on nonaccrual in the fourth quarter. Our overall CECL reserve now stands at $163 million, representing 7.6% of the outstanding principal balance of our loans held for investment. 91% of our total $163 million in CECL reserve, or $149 million, relates to our risk-rated 4 and 5 loans, including $57 million of loss reserves on our 3 risk-rated 5 loans and $92 million of loss reserves on our 6 risk-rated 4 loans. Overall, the $149 million of reserves represent 28% of the outstanding principal balance of risk-rated 4 and 5 loans held for investment. We continue to further bolster our liquidity and capital position. We maintained significant liquidity and a moderate net debt to equity ratio of 1.9x at year-end 2023, including adding back our CECL reserves to shareholder equity. Our financing sources are diverse and, importantly, have no spread-based mark-to-market provisions. On December 31, 2023, we had over $185 million in cash and undrawn availability under our working capital facility. This amount does not include other potential sources of additional capital, including unlevered loans and properties. During the year, our liquidity was further supported by $218 million of repayments and loan sales. Our net realized losses for 2023 was $10.5 million. Since our IPO in 2012, we have closed over $8 billion in commercial real estate loans and, through December 31, 2023, have recognized a total of $14.5 million in realized losses. And finally, as Bryan mentioned, we declared a regular cash dividend of $0.25 per common share for the first quarter of 2024. This first quarter dividend will be payable on April 16, 2024 to common stockholders of record as of March 28, 2024. So with that, I will turn the call back over to Bryan for some closing remarks.
Thank you, Tae-Sik. We recognize the challenges that we face with these new nonaccrual loans and the impact that they had on our financial results for the fourth quarter. Based on the progress that we are making with respect to these new problem loans, we do expect to improve our run rate distributable earnings in the near-term as we seek to recapture a portion of the lost earnings that we experienced in our fourth quarter. Our new quarterly dividend of $0.25 per share reflects our go-forward view of our near-term quarterly run rate distributable earnings, excluding losses, assuming we achieved the earnings enhancements from our contemplated resolutions. Longer-term, we believe the real estate capabilities we possess at Ares, coupled with our capital, liquidity and reserves, will enable us to maximize credit outcomes and enhance our earnings from these situations. We are cautiously optimistic that the increasing level of transaction activity and improving market liquidity could serve to gradually provide more confidence for market participants, over time. In turn, this [can serve to] position us to return to a higher level of earnings in the future. As always, we appreciate you joining our call today, and we'd be happy to open the line for questions. Operator?
[Operator Instructions] We'll take a question from Sarah Barcomb of BTIG.
I'm hoping you could walk us through your go-forward earnings power relative to this new $0.25 dividend just with the Q4 DE coming in closer to $0.20. I'm hoping you can help us bridge that gap for coverage in the coming quarters.
Sure. Thank you very much for your question, Sarah. As we mentioned on our prepared remarks, that the impact of putting 6 new loans on nonaccrual had about a $0.12 impact from what those same loans [affirmed in] prior quarter, the third quarter. As Bryan also mentioned, we are working very hard to resolve a number of those loans, a number of those 6 new nonaccrual loans as well as loans that have been previously placed on nonaccrual. As we mentioned, one of those loans, the $39 million loan out in California, that has been successfully resolved. And as we continue to resolve additional loans, I think we're making good progress on resolving a number of those [nonaccrual] loans.And really, as we mentioned, kind of setting our dividend at the $0.25 level for the first quarter of 2024, we did take into account what we believe we can achieve in terms of distributable earnings once we're able to successfully resolve some of these loans. So without getting too specific, I think we are targeting to resolve some of these loans as soon as we can. And we do believe that, once we are able to resolve these loans; the, as Bryan mentioned, the resolution will come in a couple of different forms; in some cases a sale of the loan, in some cases sale of the underlying collateral, in some cases restructuring of the loans with existing borrowers. So the resolutions are going to come in different forms. We do believe that our earnings power will go up from the $0.20 that we recognized in the fourth quarter of [2020] (sic - 2023?) largely because that was impacted by, again, the significant increase in noncore loans. So that is really our goal, is to resolve these loans and increase our earnings power so that we can continue to cover the dividend that we have set.
I appreciate you walking us through properties loan-by-loan, your expected resolutions there, so thanks for that. This one's a bit more backwards-looking, but I'm hoping you could walk us through what happened on the ground with those new nonaccrual loans, whether it was an issue at the sponsor level with buying a new rate cap or something else maybe leasing-related? Any color for us there?
Yes, I can, a bit more color, Sarah. So I would say that interest [somewhat idiosyncratic], but certainly borrower behavior shift in sentiment around an asset and support for that asset, as well as just really crystallizing some of the valuations as we've seen a bit more activity through Q4. There was more data to point to, as well as certain events within each of these specific assets, where the borrower's approach to continuing those payments runs more in doubt. So nothing overarching, just a few events that made us revisit some of [the] approach.
We'll take our next question from Stephen Laws of Raymond James.
Just [to] follow-up a little bit on Sarah's question, when you think about the potential earnings benefit as some of the nonaccruals are resolved, is that really solely related to paying off the financing associated with these loans? Or [is] it also include some assumptions around redeploying capital and new investments?
Sure. Great question, Steve. And the answer really is it's a combination of a number of things, including the 2 examples that you mentioned. So yes, in some cases, the benefit that we would see in the earnings comes from being able to pay down, either in part or in full, associated liability of some of the nonaccrual loans. So clearly, the loans are already on nonaccrual but, unfortunately, we are still paying interest on the associate liability. So to the extent that we can resolve these loans and get a full or partial repayment of the associated liability, that would obviously result in higher net income.The other, as you mentioned, is that some of the resolutions we believe will result in some net cash coming to us. Again, we haven't really built in redeployment of that cash to necessarily increase earnings, going forward, but we obviously can utilize that cash for a number of different purposes. I would say another example along the same lines is that, again, as I mentioned, some of the resolutions we're working on is restructuring the loan with the existing borrower. In some of these situations, we believe we can restructure the loan, which would potentially include some new cash from the borrower coming into the property and into the loan that would then allow us to then begin to recognize interest on some or all of the existing loan itself. I think those are just 3 examples of how earnings can be increased, going forward, upon resolving result in some of these nonaccrual loans. That's [not an exhaustive list], but I think those are 3 good examples of how resolving the loans can increase earnings, going forward.
To continue with interest income, were these 6 new nonaccrual loans on nonaccrual for the entire fourth quarter? Or did they contribute some interest income in the early part of the quarter?
Sure. Great question, and I appreciate the distinction there. So our policy is that we put a loan on nonaccrual for the entire quarter. So when we talk about the $0.12 impact, that meant that for the fourth quarter overall, for the entire fourth quarter, that these 6 loans did not recognize any interest revenue, interest income for the entirety of the fourth quarter.
And then, as we think about the interest coverage test, I think it's a 12-month look-back. But can you update us, and apologies, I haven't had a chance to get through the whole filing this morning, but can you update us on where you stand on that, whether you'll need waivers for lower interest coverage test metrics? Or how counterparty discussions are going around the developments with these loans?
Sure. Stephen, I just want to clarify your question. When you say interest coverage test, are you talking about these specific loans? Or are you talking about the company's overall interest coverage?
[With your financing], your counterparties. I believe it's typically somewhere between a 1.3 and 1.5 interest coverage test with your bank lines or your other financing facilities and any debt covenants that need to be considered or discussed around these nonaccrual developments.
Sure. As you can imagine, we have always closely monitored all the covenants that we have on our own debt facilities as well as those of (indiscernible), as well as those where we [hold as an] asset. In terms of interest coverage, we are clearly meeting the [interest coverage] test in all of our debt facilities. I think one of the very proactive steps that we have taken now for the past several years is delevering our balance sheet, right? So we have about $1.6 billion of financing that is materially down [from] a couple of years ago. And so we have been very mindful of making sure that we have the right balance sheet in these more challenging market conditions. We have increased our liquidity. We have done a number of measures, and all of that has obviously helped not only in terms of maintaining the flexibility and the balance sheet we need to work through some of the underperforming loans; but overall, it has put a little less stress on meeting our covenants. So for example, if we were levered 3 to 1, I think those coverages would be a bit tighter. But as we mentioned, we have worked very hard to delever our balance sheet significantly over the past several years, and that has helped significantly on our loan covenants themselves.
We'll take our next question from Rick Shane of J. P. Morgan.
I just want to make sure the loan that was held for sale sold at your carrying value, so no hit to book value. By our calculations, that represents about a $2.6 million realized loss. Is that correct?
Yes. So we sold the loan, as we mentioned, at $39 million, and that is really a net proceeds we received on the sale. And that was the stated fair value. So one thing just to maybe distinguish here is that, because we were under contract to sell this loan at year-end, we put this loan under available for sale. It was not held for investment. So it is not part of our held-for-investment portfolio. We did hold this at fair value, that fair value being the $39 million carrying value. And so there is no impact on book value, as you said.I forget the actual, (indiscernible) quite at the moment, the $2.6 million you mentioned.
I was just at the wrong one, Tae-Sik. I apologize. You're going to give you a better number. I figured that out.
But no, I think the important point you're making is that, again, it was sold at its stated fair value at year-end, correct, that $39 million.
And when we look at the, call it, $150 million specific CECL reserve, should the assumption be, particularly because I think, at this point, you guys have incentive to resolve this quickly and be able to redeploy the capital in order to achieve the distributable earnings run rate that you're targeting, that you will realize that those losses will largely come through in the first half. The cadence of realized losses is going to be very front-loaded in '24.
Yes. So maybe I can begin, and Bryan, please weigh in. Again, we go through our process to determine the appropriate amount of CECL reserve. I don't think it's necessarily reflective of what will ultimately be realized because, in almost all situations, these are very dynamic markets. And so the realized losses could be more, or it could be less.In terms of timing, again, as we mentioned, we're working very hard on all of these loans. I think some are more near-term opportunities. Some are more opportunities that will come out in later quarters, later periods. I would not expect all of these to be realized in the first half, for example. I do think we are always balancing, as we say, maximizing proceeds as well as accelerating timeframe, but there is a balance between those 2. There are some situations where we feel holding on, if you want to call it, or maintaining our position for a little bit longer position results in greater value that we think it's worth doing. In some situations, we are pushing very hard to something realize immediately because we don't think future value will be materially greater. So it's lots of different situations, but I would not say all of these would be realized in the first half. And again, I would not equate what will be realized losses with the reserve. I think the reserve contemplates a different analysis unless, again, it's a very near-term resolution where, for example, in assets already under contract for a specific price, then, obviously, those 2 numbers come together. But for longer-term resolutions assets, there can be variance between what the actual realized value is or the losses versus the CECL reserve.
Yes. And I'll just add to that. I think that the leverage ratio that Tae-Sik touched on earlier gives us that flexibility. So I certainly hear your point, and I think velocity is something, it's certainly part of the equation, but we're balancing that with ultimate resolution. We absolutely look forward to getting back on offense when available. And I think the resolution of some of these assets will be indicative of that. But I think the ultimate resolution is a balance of price plus timeline.
(indiscernible) question. And I think we see the logic here in terms of where the dividend has been struck. If we think about where book value is today, and looking at book, excluding reserves because I think, realistically, that will be reasonably close to the amount of book value you have on a go-forward basis. The dividend equates to a return of just over 8.5%. I think that's pretty consistent with mid-cycle returns for your company on a scale basis over the long-term. Is that the right way to be thinking of these things?
Yes, it's an excellent observation. I certainly think that is one way to, [I want to] say, triangulate to sort of a yield that makes sense. Again, I would just caution, however, that we are in, as I mentioned, dynamic market times. For example, in one sense, we're enjoying very high interest rates, with SOFR being at the 5.3, 5.4 level. On the other hand, 5.3, 5.4 SOFR is causing significant an adverse impact on real estate operating performance and values. And so there's a lot of components that go into our overall returns. So certainly, credit, certainly interest rates, certainly leverage, certainly deployment. There's a lot of factors I go into it.But I do agree with your observation that the $0.25 dividend for the first quarter of 2024, if you were to annualize that to $1, $1 be divided by the $11.50 to book value equates to that, I think you brought up 8.7% yield. I do think that's a great way to triangulate maybe the sensibility of it.But I would also caution that the story isn't fully told yet, right? As we mentioned, we have set our dividend level based upon what we believe we can earn by resolving some of the nonaccrual loans, not all of the nonaccrual loans. So we do have potential for adding in more earnings. At the same time, without going to the full list, I mean, there are lots of other factors that can and that are likely to impact our earnings going forward, as well. So that is part of the equation, but certainly not the only part of the equation.
Look, it's an interesting observation that you make in terms of sort of the long-term. I would agree with you on average over time, but that's probably 6 years out of 10 in that 8% range, 2 years out of 10 above it and 2 years out of 10 below. And we're probably in the thick of those 2 or 3 years that are below that 8.5% target.
Yes.
We will take our next question from Don Fandetti of Wells Fargo.
Tae-Sik, I guess I'm trying to just get a sense of your confidence as you think about the shorter-term. How are you feeling about the ability for just a replay of this in Q1 where you have kind of nonaccrual migration and other big reserve build? I know there's uncertainty kind of intermediate, longer-term, but how are you thinking about it in the short term?
Sure. Again, our short-term objectives is part of a longer-term plan, of course. But our short-term objective, as we mentioned, is to remain very, very focused on the nonperforming loans. It's to remain very, very focused on continuing to digitally monitor all of our loans overall. We are in a state as of the fourth quarter, as of year-end, where we have a significant portion of our capital in nonaccrual loans, and so that is clearly impacting our current income.Having said that, as we've mentioned, a number of our loans, even though they're on nonaccrual, continue to pay interest, and that interest is not being recognized. I think that interest is being used to reduce the carrying value of the loan itself. So we think all of that helps to further improve the balance sheet overall. But again, to answer your question short-term, we remain very focused on growing our income base and our overall distributable earnings. We want to continue to vigilantly work out any of the problem assets so that we can either monetize the capital that we have in the asset, we can pay down the debt associated with those assets, but (indiscernible) the liabilities associated with the nonperforming loans, and then redeploy some capital. We have a significant amount of liquidity. We will hopefully generate more capital from the resolution of some of these loans. One of the things we've mentioned is we are working very closely with many of our borrowers to continue to inject more equity into the loans themselves. But short-term, I would tell you also that we continue to see some volatility in the markets and in our portfolio. I think one of the subsequent events that we had mentioned in our filing this morning is that we had 2 loans go into default at year-end, after year-end. One loan is a $57 million loan back-line office property that matured. Obviously, that loan has been rated to 5. That's the one that Bryan had mentioned we were pushing to sell before the year-end. We continue to push to sell that loan. So the resolution of that loan will be a material part of the business plan, going forward. The other one that we mentioned is the $18.5 million [mezzanine] New Jersey loan. That loan also went into default as a result of the borrower not meeting its January interest payment. Unfortunately, that loan remains in default end of January, and now February payment has not been made. But that loan, as we mentioned, has been on nonaccrual for the past couple of quarters. So that loan going into default, while it's very disappointing, obviously, has already been on nonaccrual, has been rated a 4. So there continues to be movement in the portfolio.
We'll take our next question from Steve DeLaney of Citizens JMP.
We're starting to see something interesting this quarter and hearing anecdotes that there are a number of debt funds, or even hedge funds, that are starting to look around for opportunities to kind of opportunistically buy loans from -- I'm sure they're talking to the banks, but we've seen evidence that they've been talking to the commercial mortgage REITs, as well. I'm curious if you're receiving any? If you could just say generally, are you receiving these types of inquiries by third parties looking to kind of step in so that you can avoid foreclosure and all that mess and actually just lay off the loan to somebody who works not in a public company environment and can operate a little differently? Just curious if you're seeing this secondary market and distressed loans picking up at all?
Yes. It's a great question, Steve. I think the loan held for sale at year-end was a good example of executing on just that strategy. I think there's 2 major narratives in commercial real estate. Well, probably more, but one of which is this wall of maturities and the other is this wall of capital. And I think certainly you touched on a little bit of the macro environment shifting, and part of that is that the capital on the offensive side being dislodged and becoming more pro-business, I would say.So I think that you're seeing a good reflection throughout the space of deal activity. And in general, the first market opportunity in commercial real estate will come in the form of credit, whether that's in new loans that are attractive on a relative value basis or purchasing loans either for control or for yield. So I think you're spot on. The activity is here, and I think it will continue to progress. But the amount of capital that's out there that needs to be spent in the space is significant. So the trend that you've seen or you're hearing about, I would expect it to continue.
And I would have to think the Fed is kind of giving us a head-fake here, but I'd have to think, if we start getting into the middle of this year and there is more of an expectation for cuts in the second half of the year, that that may make those potential buyers more aggressive, because you're creating a more positive sentiment for the market generally, and people are going to be less willing to sell at large discounts. So I could see this interest or this opportunistic money really picking up as the year goes along.And then the second thought I have is I've been hearing this about the banks. We all know what the capital issues are with the banks, but we're hearing that construction loans at the banks, that the banks are going to manage through those, but probably will be less likely to move into a bridge lending phase, and that that would be, maybe when we get to late '24, early '25, we could find a new wave of lending opportunities for the commercial mortgage REITs with paper coming off the bank's balance sheet. Do you see that type of opportunity as well? Or am I getting ahead of myself there?
I think, If you think about the concentration of commercial real estate debt within the banks, and certainly when we think through the real estate capital treatment for the bank balance sheet on CRE, and if you overlay that regulator or Fed focused on the banking sector, it doesn't take a large shift of the allocation of real estate debt from banks going into the private markets to create a pretty substantial opportunity set to invest into. So that's certainly what I think Ares and our peer set is playing for, is that continued shift. I think it's going to be a great opportunity to partner with the banks in this next evolution of the real estate debt market. So I would certainly [look towards] that. I think, yes, you were (indiscernible).
Congratulations on the progress you're making. I know it's a slog, but I think we have better days ahead for ACRE and for the group as a whole.
We'll take our next question from Doug Harter of UBS.
I was just hoping you could give a little more update on the multifamily portfolio and kind of, given the move-in rates, how you think that that portfolio is going to be able to handle refinancing?
Yes. So (indiscernible), I mean, one of the benefits of the multifamily market is the continued capital markets participation of Fannie and Freddie as well as it being a more friendly bank asset, as well. I'd say that we've seen supply uptick nationally. I think market-to-market that's being received differently. Largely speaking, within our portfolio, we've seen positive progress on the leasing side. So I think it will be an opportunity set for the foreseeable future. I think, when we think about it structurally, you're still going to be short despite the supply headwinds that have been fairly well-publicized. We're still going to be short over the next 5 years 4 million, 5 million, 6 million residences in the United States, especially if you look at a macro level of immigration returning rate.So in terms of liquidity, the buyers, the owners of multifamily real estate assets are seeing the short-term supply issues are dwarfed by the long-term fundamental shortage, and you're starting to see the performance of the underlying assets reflect that. So short answer is relatively stable performance within our portfolio. I think that the capital markets functionality will continue to support these assets and the equity markets, private equity markets for multifamily will continue to expand.
[Operator Instructions] We'll move next to Jade Rahmani of KBW.
Just to follow up on your answer to Doug's question, Green Street estimates multifamily values are down around 28% from the peak. I mean, when we hear answers like that, it's as if that's a nonevent. So either we disagree with Green Street, or we need to recognize that there is capital stress in a lot of the multifamily deals that was record issuance in 2021 and 2022. So just to ask it another way, how do you expect this to be reconciled over the next year in multifamily?Secondly, I would like to ask about 2 multi-families in which Ares was involved. I think that they are likely in the ACRE portfolio but wanted to check. One was a large Chicago multifamily and another is in Dallas, and those look like, based on the real deal, there are performance issues there.
Yes, Jade, I guess [that I don't want to] misrepresent. I think that, if you go back to certain markets and you were in the spring of '22 purchasing at, I'd say, trough cap rates, there is probably value decline in excess of the 28% you're citing through Green Street. In many instances, we've seen rent growth, and I think those buyers saw the perceived rent growth in certain markets continuing unabated with expenses that didn't necessarily go in tow with that.But largely speaking as a lender, even if you subscribe to the Green Street number, moderate leverage, there's still equity to protect in those assets. I think you will see some transfer of value from equity to debt. So it's not that there won't be distressed. I just think that, when you consider overall loss severity in the space to the lender community, I think that will be muted relative to if you look at the office sector, for instance. So it's not to say that there won't be transfers of assets given that value decline. And certainly, if you got the [vintage wrong], if you got the expense load wrong, there will be distress. And I think the 2 assets we are talking about reside in different vehicles. The press doesn't always get the lender correct there. So Ares is associated with those assets, but they are not ACRE assets specifically.
So in terms of the transfer of assets within a portfolio such as mortgage REIT portfolio, if you don't expect ultimately significant loss severity to the lenders, how do you expect this to play out? Do you see the mortgage REITs being active in bringing in additional capital to recapitalize transactions?
I think that's certainly a possibility. But I think despite the technology overlay we've seen in the multifamily sector, specific asset management capabilities within the borrower community have never been more important when you think about some of the issues around [broad] and otherwise in the apartment sector. How you manage these assets, it's a good bit of value creation.And I do think, to your point, Jade, there's ample liquidity to come in on the private side alongside existing lenders, recapitalizing an asset and bringing to bear improved asset management or property management from there. So I think you're spot-on that this might take the form of partnership rather than outright sales to kind of stabilize the valuations. And I think, to the earlier point on the decline in rates, or even the stability around rates, multifamily over the next 5 years will be fairly well-correlated to the rate environment.
And then, lastly, if I could squeeze one more in, there was an industrial property. I can't recall offhand if you've previously discussed this, but it was moved to nonaccrual status. It's relatively small compared to the average at $19 million, but we haven't seen much pressure there. So could you comment on that situation?
Yes. That's just a redeveloped asset on the West Coast. I think basically, in the analysis of that property, the dialogue with the borrower is dynamic, and it is a relatively small asset, however. So active discussions with that borrower with a rate cap coming up is really the catalyst for the analysis.
So the nonaccrual was due to the rate cap, not leasing outlook or supply competition or anything of that nature?
I think it was slower than expected leasing velocity alongside a near-term event of the rate cap.
And there are no further questions at this time. I'd be happy to return the call to Bryan Donohoe for closing comments.
Yes. Thank you, operator. And I just want to thank everybody for their time today. We appreciate the continued support of Ares Commercial Real Estate, and we look forward to speaking to you again on our next earnings call. Thank you.
Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately 1 hour after the end of this call through March 21, 2024 to domestic callers by dialing (800) 723-0544, and to international callers by dialing area code (402) 220-2656. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website.