US real estate managers, and their global counterparts, are looking at ways to expand their debt strategies.
The interest is spurred in part by institutional and private investors wanting to realign their portfolios, increasing allocations to debt along with strategies including industrial and affordable housing, says Mike Sroka, chief executive and founder of Dealpath, a deal management platform that handles acquisitions, dispositions, development and financing.
“Even pre-pandemic, there was a real acceleration of the creation of debt funds,” Sroka tells Real Estate Capital USA. “At that time, we were in a long bull market, or perhaps even past the peak of the market, and investors were seeking more compelling risk-adjusted returns. That seems to be continuing and there is a significant amount of new capital formation focus on debt.”
According to data from affiliate title PERE, several major US managers have launched or closed debt-focused funds this year, including Cerberus Capital Management, Canyon Partners Real Estate and BlackRock Real Estate. At the same time, North
America-based firms make up more than half of the world’s 50 largest real estate debt managers.
The US debt market is attractive to a broad group of global investors for its stability, says Jon Barlow, founder and chief executive of Finitive, a data-driven private credit platform.
The US has stable laws regulating foreclosure and limiting exercise of eminent domain that make it an easier place to invest, says Barlow: “Many other countries still do not have mortgage-like instruments as a universal standard.”
Barlow is seeing more strategies that tap into both short- and longer-term lending opportunities, some of which have been heightened due to the dislocation stemming from the pandemic. “Obviously, there is a phenomenal current opportunity for shorter-term loans with very high returns,” he says.
The growing commercial real estate collateralized loan obligation market has also dovetailed with the expansion of debt funds, notes Don Moses, a managing director at Arena Investors.
“Many of the debt funds are also taking advantage of the current demand for securitized product as the CLO markets have been very strong, allowing access to inexpensive financing that enhance the debt fund returns,” he adds.
Moses says many of the new funds launched by equity investors are targeting shorter-term bridge loans on transitional assets. “The bridge loans produce marginally higher yields than longer-term permanent financing, have less duration risk and currently are very popular for securitizations in the CLO market.”
Getting into debt
But because of the comparatively small size of the market for publicly traded real estate debt securities, more capital is being raised for lending funds. “Given the relative value of private transactions versus publicly traded debt securities, such as commercial mortgage backed-securities, funds of all sizes have pivoted or just focused more on non-securitized US real estate as a solid relative value play,” Barlow says.
Consultant RCLCO Fund Advisors expects to see more activity from private capital targeting debt funds, in part because commercial banks have less capacity to lend on transitional or risky assets in the wake of the global financial crisis, according to CEO Taylor Mammen.
“Secondly, I believe the market is eager for assets that generate relatively stable yields that traditionally have been offered by fixed income investments, but at rates that come closer to their actuarial targets. Real estate debt, levered either at the fund or asset levels, has been a good source for this,” Mammen says.
RCLCO believes there continues to be a strong place for real estate debt in investor portfolios.
“It’s critical, though, for investors to evaluate what role they want real estate to play within their portfolio and how it will be benchmarked within their portfolios,” Mammen says. “The answers to these questions will help determine which specific strategies investors should pursue, whether lower-risk senior secured notes on stabilized assets, mezzanine or bridge lending, construction or other transitional strategies.”
Mammen does have one caveat, however: “We also think it’s important for investors to select partners with a deep track record underwriting and investing as lenders, but with deep real estate knowledge – which isn’t always the case.”
This trend toward debt is likely to persist, according to Bruce Stachenfeld, chairman of New York law firm Duval & Stachenfeld.
Over the long-term, this means more debt managers are likely to expand their existing businesses – and more equity managers will look at diversifying into the asset
“More lenders are starting to realize that a core, open-ended debt fund is a nice strategy that gives income to investors who want to plonk their money into it and clip coupons,” Stachenfeld says.