While many investors typically think of real estate investing in terms of real estate investment trusts (REITs) and direct investments in properties like homes, apartments and warehouses, there are other ways, including the private real estate space.
In the current interest rate environment, one of the most talked about areas within the private real estate sector is real estate credit, an asset class which has historically been relatively opaque and predominantly available only to institutional investors.
At a time when financial professionals are increasingly looking for differentiated alternative investment products for diversification1 and return benefits, these are the three things you need to know about the growing asset class.
Opportunity for non-correlated returns
One of the biggest draws to alternative investments in general, and a primary reason for the recent uptick in demand for these asset classes among investors, is their distinct risk/return profile and non-correlation to public markets.
Real estate credit is no different than other alternative investments in that regard.
Over the past 10 years, real estate credit has offered high single-digit income returns with significantly less volatility than REITs or equity and fixed income markets.2 This asset class has been around for many years in the institutional arena, and it has a track record of stable and non-correlated returns. Specifically, private real estate credit has delivered an 8.5% annualized total return, in line with direct lending and real estate equity strategies, but with significantly lower volatility.3
This return profile is derived from several sources:
- Returns are derived from current income, which comes from interest payments made by the borrowers on the underlying loans.
- Loans are made at conservative leverage levels (on average 65% of the value of the underlying property) and in the most senior portion of the capital stack, with the goal of providing insulation in the event of a real estate price correction.
- Because loans are secured by hard assets, the asset class has historically benefitted from a low loan default rate when compared to other lending products.4
One of the largest and most well-established fixed income asset classes
Historically dominated by banks, insurance companies, and government agencies (Fannie Mae and Freddie Mac), real estate credit was the fourth largest fixed income asset class in the U.S. as of 2023.5 This six trillion-dollar asset class eclipsed the municipal bond market in size, but has so far been difficult for retail and high net worth investors to access.
The asset class is also growing, with expectations for record high loan demand over the next four years, right at the same time as many of the traditional dominant players, such as banks, are expected to be less active in the space. While insurance companies and institutional investors continue to increase exposure to private real estate credit, new investment vehicles are continuing to emerge in the space to fill the gap. As a result, the asset class is becoming more accessible to high net worth and retail investors.
A unique window of opportunity
Since the Silicon Valley Bank crisis, the traditional lending industry has been tightening their lending standards across the board in response to higher interest rates and inflation, which has created a mismatch between credit supply and demand for the real estate industry.
With regulatory pressure and tightening standards limiting banks’ ability to meet the demand for lending in the space, private lenders have a distinct opportunity to fill that void and capitalize on a “higher for longer” interest rate environment which has historically been positive for real estate lending.6
Read the full article here by Charlie Rose, Advisor Perspectives
