New performance benchmark draws closer to launch

A new debt fund index from CREFC and NCREIF is being developed to provide extra transparency for investors conducting due diligence around return generation and potential risks.

The next evolution of the debt fund space may find its root in a still-developing index being jointly created by the National Council of Real Estate Investment Fiduciaries and the Commercial Real Estate Finance Council.

The duo of industry-representing associations are entering their third year of co-development on the commercial real estate landscape’s first debt fund index and drawing closer to a full launch as the proposed benchmarking tool goes through further testing – and tries to attract a handful more of new debt fund participants. The move toward a formalized index comes as more institutional investors are turning toward debt strategies, with just under $30 billion raised in 2021.

Lisa Pendergast, executive director of CREFC, says there is still significant growth to be realized in debt assets under management given the returns registered by such funds in recent years. “However, there is currently no fund-level debt fund index that can be used by investors to benchmark performance,” Pendergast says in an interview with Drew Fung, managing director and debt fund portfolio manager at Clarion Partners, who is part of the effort to develop the index. “This is perhaps surprising given the abundance of indices available to investors to benchmark performance of various other asset classes.”

The index would provide extra transparency for investors conducting due diligence around return generation and potential risks and rewards, a key to unleashing expected growth for the sector.

“As in many things, the devil is in the details,” says Pendergast. “It’s vital that the index allows for a like-to-like comparison and well identifies the varied investment strategies in the market today – think core, core-plus, value-add, etc – which are well-worn terms in equity real estate circles but not widely used in the debt fund sector.”

Respectable returns

According to CREFC, early data shows CRE-focused debt funds logged performance results only slightly below that of equity funds from 2014 to 2020 and did so with far less return volatility and less risk.

“It’s vital that the index… identifies the varied investment strategies in the market today”

Lisa Pendergast
Commercial Real Estate Finance Council

Pendergast says such performance should prove attractive to those who currently do not have a permanent capital allocation to CRE debt and provide a measuring stick to support future allocations to the asset class.

“The benefit of a new index for debt is the ability to develop a more bespoke performance measure for open-end funds that deploy capital across a variety of CRE-focused debt vehicles, such as first and second mortgages, bridge and mezzanine loans, and preferred equity,” Pendergast says. “There simply is no index today that captures the strategies and debt instruments that comprise today’s debt fund activity.”

Pendergast and Fung say CREFC is now working on gathering additional investor support and manager participation as well as the development of industry reporting standards to bolster and hasten the index’s development.

While timing of the launch is tough to pinpoint at present, the two note that almost a year was spent in developing a framework for the index, determining what to track, how to track it and what to report.

Pendergast and Fung say the latest effort to develop a debt fund index is not done yet – the organizations will be focused on the project for some time. “That said, both traditional balance sheet lenders and the structured finance capital markets continue to provide institutional investors with highly liquid options for investing in commercial and multifamily real estate,” they noted.