By Diane Harrison
It’s been years since investors have been able to get excited about the term "yield" when referencing their investment portfolio. Too many individuals have been hanging onto cash while searching fruitlessly for somewhere other than equities to put their money to work. Advisors haven’t been much help in this effort either, often acknowledging that, unless and until something interesting presents itself, sidelining a pile of cash might not be the worst plan in prudent money management.
ENTER THE INTERESTING ALTERNATIVE…
However, there’s a relatively new kid on the block who is shaking things up--private real estate debt lending. There are two main influencers on this burgeoning business: one, a lending gap created by banks exiting the middle market lending space in the wake of the now infamous financial crisis. The crisis spawned by numerous bank capital regulations restrict this piece of the lending pie to such an extent as to make it unattractive to the banks. Two, the prolonged zero-interest rate environment with the Fed’s thumb on global rate engines has also created a dearth of commercial mortgage-backed securities, historically a support pillar to the lending market, now shackled by its own growing regulation.
Back in February, Barrons covered this in “Bet Your Real Estate Dollars On Debt In 2016.” The article offered this view: “The more restrictive regulatory environment for the large banks, as well as the wall of commercial real estate debt that is maturing over the coming years, have combined to create an attractive opportunity for non-bank finance companies with private real estate debt funds, which clearly stand to benefit from this confluence of factors,” says Jim Burns, member and head of KKR’s individual investor business.
In September, Preqin released its latest survey results that included some interesting findings about private debt. As one of the leading sources of information for the alternative assets industry, Preqin surveyed more than 160 institutional private debt investors and found that, in terms of focus for allocations going forward, North America has traditionally seen the greatest level of private debt activity, and 47% of investors believe the region currently presents the best investment opportunities. Also, the strategies that look most compelling to investors include direct lending (56%), mezzanine (53%) and distressed debt (49%).
FILLING THE VOID WHERE BANKS FEAR TO TREAD
Wealthy investors have a long tradition of putting their money to work in real estate, although historically it has been in the hard asset itself. Now however, investors are gaining interest in the lending segment of private real estate investing, by lending to developers who focus on building or renovating high-end properties. The strategy has an attractive potential payoff: anticipated returns typically range between 8-12%. These yields are pulling both investors and fund managers to the sector, as the US market offers several regional locations in which this type of lending can flourish.
One such region offering attractive private lending opportunities is California, where specialty players are active in the private loan market. Cities like San Francisco, Los Angeles, and other coastal urban centers are seeing growing interest in the renovation and resale of a variety of both residential and commercial property types. There is an ample supply of potential projects and a lack of market participation from the larger institutional lenders, which increases the appeal for niche lending portfolio managers. An added benefit for the investors in these small scale investments is that often, the average holding of such investment properties is roughly 2 years, which plays well into these investors’ desire for faster turnaround and liquidity of their investment funds.
One active West Coast player in the middle market lending space is finding growing opportunities to answer the question: Why don’t banks fulfill this lending gap in Ca for small scale developers? States Jan Brzeski, founder of LA-based Arixa Capital Advisors (www.arixacapital.com),“The banks are too slow to accommodate the small developers in this space, as the California market dynamics requires them to be both nimble and well-capitalized to turn properties around and resell them into this competitive market. The banks also require too much liquidity, assets, and income from the developers to adequately meet the needs of most for timely loans and construction activity. Developers are willing to pay a premium for the access to capital and speed to market that our lending platform can provide.”
Arixa’s business model of creating a basket of loans on projects with talented developers, originated and managed by a team of experienced portfolio managers, means investors in their funds earn attractive monthly income in the high single digits with a significant margin of safety and low correlation with most other investments.
THIS CREDIT CRUNCH HAS AN APPETIZING APPEAL
Investors are finding these types of middle market lending solutions to be both practical in practice and compelling as investments, with a strategy that has legs in the current market environment. Overall supply and demand trends are likely to continue, as banks have retreated from this market segment and are unlikely to reenter, given the regulatory burden it entails.
Throughout the US, particularly in demand-centric regional residential and commercial areas on both coasts and in the south, developers will be repeat borrowers as they continue to uncover real estate opportunities that support the borrowing terms provided by these innovative lending players. And most importantly, investors are eager to participate in the real estate markets they have long favored as a key component of their portfolio allocation preferences, with understandable risks and attractive returns.
Diane Harrison is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002 specializing in alternative assets. She has over 25 years’ of expertise in hedge fund and private equity marketing, investor relations, articles, white papers, blog posts, and other thought leadership deliverables. In 2016, Panegyric Marketing has been shortlisted for Family Wealth Report’s Outstanding Contribution to Wealth Management Thought Leadership and received AI Hedge Fund's Outstanding Contribution to Wealth Management Thought Leadership, M&A's Excellence in Financial Services Marketing Communications – USA, AI’s Innovation in Alternatives 2016, and Wealth & Finance International's Best In Funds 2016 – US and their Women in Wealth Awards Best Financial Services Marketing Company - New York. A published author and speaker, Ms. Harrison’s work has appeared in many industry publications, both in print and on-line. To read more of her published work in alternatives, please visit www.scribd.com/dahhome. Contact: dharrison@panegyricmarketing.com or visit www.panegyricmarketing.com.