Real Estate Debt Funds: Pouncing on the Opportunities
Real estate debt is still a small sector of the asset class. Debt funds account for 16% of private real estate fundraising. However, in the face of declining real estate valuations and rising borrowing costs, both of which are unfavorable for equity investors seeking to undertake direct real estate acquisitions, it presents some opportunities for debt investors.
This is because lenders are increasingly decreasing the amount of leverage they offer to borrowers and charging higher interest rates to compensate for higher perceived risks.
“Considering the rising high interest rate environment, investors are increasingly looking to reallocate some of the capital towards debt investing to seek diversification and stability as debt strategy is a lower risk alternative to shield them from market volatility and provide protection,” explained Neils Brookes, global head, capital markets, Knight Frank.
The biggest misperception about commercial real estate debt “is it has the same risk profile as real-estate equity, and that couldn’t be further from the truth,” added Alex Chaloff, CIO at Bernstein Private Wealth Management.
ACORE Capital, Brookfield Asset Management, and Kennedy Wilson are among those that have completed or are currently raising large funds to pursue debt strategies.
Last week, ACORE announced it held the final close of its oversubscribed ACORE Credit Partners II with total equity commitments of about $1.4 billion; the largest in San Francisco-based ACORE’s series of commercial real estate credit funds.
“We believe the success of this fundraise – especially in a very difficult capital raising environment – is a testament to our track record, relationships and the incredible opportunity we see to deploy capital into transitional real estate over the next few years,” said Warren de Haan, CEO of ACORE.
Brookfield is currently raising capital for its fifth vintage global opportunistic real estate fund, Brookfield Strategic Real Estate Partners V, with a reported target raise of $15 billion.
Meanwhile, global real estate investment firm Kennedy Wilson announced in March that its real estate debt investment platform had more than doubled over the previous year, with $7 billion in originations and a “strong” pipeline of new opportunities.
Since the acquisition of a $4.1 billion loan portfolio in 2023, Kennedy Wilson has closed approximately $500 million of new loans with $1.3 billion currently expected to close by the second quarter, focused on multifamily and student housing construction.
Across the pond, capital is also being raised at a healthy clip. Last month, London-based M&G Investments, one of the largest alternative lenders in Europe, held the first close of its latest vintage of real estate debt funds at $450 million.
“For debt providers, the relative risk adjusted return profile for new real estate credit today is very attractive,” wrote David White, Head of Real Estate Debt Strategies, Europe at LaSalle. “Higher interest rates have helped to improve the return profile, and new loan detachment points are generally trending lower, particularly in instances where borrowers are willing to show support for underlying assets and commit additional cash to a transaction.”
With PIMCO forecasting that more than $1.5 trillion in U.S. real estate debt will mature by 2025, and $650 billion and $177 billion due in the same year in Europe and Asia-Pacific, respectively, real estate debt funds will be well positioned to inject liquidity into companies with limited capital structures.
“We believe that today’s market landscape characterized by high base interest rates, widening credit spreads, lender friendly loan structures, and the ability to drive terms in a constrained market has created an attractive risk-return proposition for privately originated real estate loans,” wrote Apollo in a white paper titled, Mind the (Funding) Gap: Finding Opportunities in Real Estate Debt Amid Dislocation.
Today, lenders can reduce risk by offering debt financing at lower loan-to-value (LTV) ratios than identical loans from a few years ago. According to Trepp and Goldman Sachs, the average LTV ratio on new deals has fallen to 51% since Silicon Valley Bank’s bankruptcy in 2023, down from the post-Covid average of 60%.
However, distress is always on the back of minds, with the anticipation that investing opportunities will surface as the estimated $1.5 trillion in commercial real estate loans mature in a market where interest rates are higher, and lending is more conservative.
Some investors are ready to pounce on the opportunity. Buyers of distressed real-estate debt stand to make significant gains over the next few years, according to Josh Pack, co-CEO at Fortress Investment Group. “This is going to be a trillion-dollar opportunity,” he told Bloomberg News in a podcast.
