Niche property lending requires different pros-cons considerations

Lending to a singular alternative real estate sector means a firm must be ready to underwrite a property type’s unique risk and demonstrate specialist expertise.

As real estate alternatives and debt strategies gain more capital, attention and traction in the market, it will only be a matter of time before a sub-sector dedicated to a combination of the two emerges.

At this point in the cycle, traditional real estate properties are so competitively priced many investors have turned their eyes to alternative property types or real estate debt, areas attracting fewer organizations while supposedly offering higher returns. Private real estate performance data for alternative asset classes are hard to come by, but the listed side demonstrates a stark disparity: Office REITS returned 0.83 percent this year as of August 31, compared with the 9.07 percent for healthcare and 11.52 percent for manufactured homes during the same period, according to FTSE Nareit US Real Estate Index Series.

And so, unsurprisingly, a private asset manager has combined alternative real estate and financing strategies.

Last week, Locust Point Capital saw success in closing its debut fund focused on senior housing lending. The New Jersey-based firm raised $312 million, 25 percent more than the $250 million it originally targeted. Investors, including endowments, pension funds, foundations and several US family offices committed capital to the fund. Managing director and partner Eric Smith told Real Estate Capital’s sister publication PERE that 15-20 investor groups even had to be turned away.

Investors were attracted to the notion this firm is providing a specific and established need in the senior housing industry, Locust Point’s placement agent told PERE. They were comforted by the firm’s longstanding relationships with senior housing operators and by the short duration of the loans it plans to offer, which, they believe, lowers their risk.

For Locust Point, the fund is a continuation of the strategy it used before spinning out of private credit firm Contemporary Healthcare Capital. It will pursue short-term lending to senior housing owners/operators, a strategy that has historically produced returns of 1400 basis points over the 10-year treasury from 2006-2015. Specifically, Locust Point will provide $3 million-$5 million short-term loans, refinanced within 12-24 months, to firms looking to own and operate senior housing.

Naturally, the key risk for investors comes in the underwriting of the underlying real estate. Alternative sectors carry more operational risks than traditional office, multifamily or retail properties. Senior housing is particularly operator-intensive because of its large care component, way more so than multifamily, for instance. Lenders must be aware of the unique challenges that their borrowers engage when underwriting, and they must be prepared to address them head on if the borrower defaults. Taking the keys back of a care home is an entirely different challenge to taking them for an office.

And, as one consultant reminded us, the market for alternative real estate is smaller than the mainstream and that bumps up exit risk. Fewer players equals less liquidity and thus assets harder to find solutions for if exits are required.

While most real estate debt funds make some allocation to alternatives, it is unusual to see a debt fund focused only on alternatives, let alone a single alternative property type. Investors are in unchartered waters when making their pros-cons determinations: alluring as you are accessing a niche property type via a method supposed to bring inherent safety, but daunting given the high levels of expertise required to buy and operate such assets.

This fund’s performance, and those that follow in its footsteps, will likely go some way to letting us know whether such an acute bet is worth it. Manage 14 percent returns from a debut fund and Locust Point’s investors will be saying it is.

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