Walton Street manages down debt fund performance expectations

The Chicago-based manager’s latest real estate debt fund carries the same strategy as its predecessor, but the lower return targets are a function of the late cycle, sister title PERE has learned from a source.

Investors in Chicago-based manager Walton Street Capital’s latest debt fund have been braced for a small target performance reduction.

The guidance has done little to dampen investor support for Walton Street Real Estate Debt II, however. In early February, the firm raised a record $1.52 billion for the fund, its second value-add/core-plus real estate debt fund, significantly surpassing its predecessor’s size.

Sister title PERE has learned from a source familiar with the fundraise the firm is targeting 9 percent net returns from the vehicle, brought to market in 2017 with a $1.25 billion target.

Walton Street declined to comment on the fund. However, an April 2019 report by the Arkansas Teachers’ Retirement System, which committed $40 million to WSRED II, confirms the fund is targeting approximately 9 percent net of fees, around 100 basis points lower than the return target for its $654 million debut WSRED fund. The 2012-vintage vehicle returned a 10 percent net internal rate of return. According to a 2014 report by the Texas Municipal Retirement System, WSRED had a 9-11 percent net return target.

WSRED II’s debt investment strategy is focused on the origination and structuring of floating-rate debt investments secured by income-generating assets in major US markets. According to a press release by the firm, approximately $250 million from WSRED II has so far been committed to debt investments in mostly industrial and multifamily assets, with limited exposure to office and hotel assets.

The source told PERE the decision to lower target returns was driven by the fact investors view the product as a “core alternative.”

“WSRED II has the exact same strategy and risk profile as WSRED. But to generate the same level of returns as WSRED the firm would have needed to take on construction financing, bring in a subordinate piece of debt, or use leverage upon leverage,” the source explained.

PERE understands except one investor, all other LPs re-upped into WSRED II. New investors include multiple undisclosed Korean institutional investors.

Historically low interest rates have led to an expansion in the US commercial real estate debt market, with financing activity reaching $703 billion in 2019, a 17 percent increase from 2018, according to Newmark Knight Frank’s Q419 US Capital Markets Report.

Debt funds across the risk spectrum have proliferated as a result. The report estimated as much as $38 billion raised by closed-end debt funds remained undeployed in 2019 due to increased competition.