Why Real Estate Debt Funds Should Be Part of Your Investment Portfolio
Real estate debt funds are relatively new players in the investment field, having blossomed in the wake of the 2008 financial crisis. Traditionally, investors have been recommended to look at a blend of investments, including equities, with a view to realizing capital growth over the medium to long term. Yet, real estate debt funds now form the core of many portfolios; in his blog post, Private Real Estate Debt: The Pandemic’s Impact and the Industry’s Future, Craig Solomon, CEO of Square Mile Capital writes:
“Private lending has been one of the standout growth stories in private real estate over the past decade… the industry stands at $190 billion in aggregate assets under management…”
Meanwhile, investment giant Blackstones currently has the largest real estate credit fund ever raised. How does the rapid growth of these funds impact traditional investment advice?
The attraction of equities has been high returns when averaged out over a long period of time and, for the long-term investor, they have generally proven to be reliable. However, the stock market is cyclical; while equities do indeed perform well in the long term, the market is often volatile – those high returns over time result from an averaging out of the highs and lows of the market over years, or even decades. Investors forced by unforeseen circumstances to sell stocks when the market is in a downturn, will not realize these promised returns and may possibly lose quite badly. Additionally, they must live with the stress that accompanies sudden losses in the market, even if they know the market will eventually recover.
On the other hand, real estate debt funds offer the benefit of a predictable and stable income, enjoying certainty in the capital stack – as senior debt – and also benefiting from diversification, with investment capital spread across a large pool of loans to mitigate risk. Real estate debt funds are comprised of equity-based capital that provides qualified borrowers with real estate loans backed by collateral. Given the collateralization and the priority, as senior debt, for repayment, investment in real estate debt funds can be seen as safe and reliable, while avoiding the volatility of equities. Additionally, real estate debt funds generally involve shorter term investments than equities, with the option to recycle funds during the investment period. Lower fees also make them attractive to investors.
Advantages of real estate debt funds compared with equities:
A steady, high-yielding income, sometimes in the teens
Diversification – to mitigate risk
Collateralization, and priority for repayment – as senior debt in the capital stack
Lower fees, from 1% to 2.5%
Shorter investment periods
So far, so good; nonetheless, the COVID-19 crisis has understandably given investment gurus pause. While detailing, on the one hand, the rapid growth and adoption of real estate debt funds over the last 10 to 12 years, Craig Solomon recommends caution going forward into the post-pandemic economy. He points out that:
“…[D]ebt managers are for the first time dealing with the asset management challenges of loan defaults, the need for loan modifications, and the exercise of remedies.”
The post-COVID economy is obviously difficult to predict, but investors and lenders of commercial real estate debt who have leveraged prudently and are not troubled by liquidity issues should find themselves well placed to retain market share, using their assets to make new loans once the “new normal” is established.
Global head of Blackstone Real Estate Debt Strategies, Jonathan Pollack, was optimistic in an interview with the Wall Street Journal:
“There’s an expectation that there will be a greater opportunity in real estate debt than there has been.”
Blackstone’s real estate debt business currently has $26 billion of property debt assets under management. With this investment giant clearly demonstrating such confidence in the future of real estate debt funds, perhaps we should all be reassured regarding their role in the post-pandemic investment market.
The Real Deal – September 2020
Craig Solomon, Square Mile Capital – July 2020
Jonathan Pollack, Blackstone – September 2020