Right now, there is much uncertainty in the investment world. It is difficult to have a strong opinion about what an asset should be worth in one year let alone five or ten years.
With inflation, one might say most things will cost more in the future than they do today, but that doesn’t mean they will be worth more. This disconnect between cost and value is part of what makes it difficult to invest confidently today.
This is especially true for real estate values. Often times when rents are on the rise, so are expenses. The net result might still be higher net income but if interest rates are also on the rise, the value of that income and therefore the value of the underlying asset may take a hit. This is essentially where we are today in the real estate investment realm.
When there is uncertainty, investors want to be risk off. They want to wait and see and may not come off the sidelines until they feel they see a bottom or some evidence of stability and path toward growth. Investors don’t want to catch the falling knife.
In the meantime, most investors want to keep their money working for them and don’t want to leave it all in cash. Paying down debt might seem like a good use of cash but maybe not. If the debt being repaid has a really low interest rate then it might be better to leave that debt alone and instead invest in new debt. Instead of paying of a 3% loan, it might be better to buy a 4% Treasury Note. If a 4% “risk-free” rate isn’t too exciting, there are other higher yielding debt options available.
Professional fund managers make money by putting other people’s money to work. So, if investors don’t want to put money in funds that buy assets today, maybe they will put money in funds that lend on them.
Investing as a lender or in a debt fund provides some relatively attractive benefits. Investors can receive a fixed return in the form of interest payments and have safer security at a discount to the underlying asset value. Debt investors give up the benefits of ownership, namely they don’t directly participate in any value growth and they don’t get depreciation benefits.
Enter: Debt Funds
There are more debt funds in the market today than maybe ever before and their target capital raise is higher than ever. This article summarizes fund raising activity with some historical context. The data source is Preqin.com.
This is shared for informational purposes without spin or an agenda. Another article will be posted that looks at the differences between debt fund options, from an investor perspective.
Private Real Estate Funds Under Management
The chart showing growth in capital allocated to the private markets for real estate assets is something to behold. That type of growth begs a few questions. Is it too much or is it appropriate given how real estate has matured as an asset class? Is the trend about to reverse or is this a new norm?
Dark blue is dry powder or capital not invested. And pink is unrealized value or capital already put to work. Looking at that chart, one can’t help but think – what goes up must come down. But is it that simple or is this capital allocation here to stay? Is this the desired result of Dodd-Frank and the regulations put on the banking industry back in 2010 or has the pendulum swung too far? We will know the answer to that in time.
Meanwhile, we can look at the fund raising activity by year over the same period – and the very recent change. It definitely suggests that the growth in private real estate fund raising has slowed. Although, the 2023 column is not too meaningful representing one month. The chart represents private real estate capital funds for all strategies, including core, core plus, opportunistic, value-add and debt.
While the fundraising pace has slowed in aggregate, the pace of capital raising for debt strategies has not slowed nearly as much. The table below is specifically for debt strategies in North America.
Source of Funds & Funds in Market
The 50 largest investors in these funds are Insurance Companies ($5.4B), Sovereign Wealth Funds ($4.3B), Public Pension Funds ($4.0B) and the remainder are classified as Fund or Asset Managers, Banks, and Corporate Investors (all combined for approximately $6.0B). That composition might be expected and the top managers are generally well known but what is interesting is the strategy for each fund in the market. Opportunistic and Value Add strategies are dominating the flow of capital followed by Debt strategies.
Debt Funds In Market – Feb 2023
There are currently 139 debt funds in the market in North America, according to Preqin.com. The total capital raise is targeted to be $33 billion. That equates to an average $388M per fund. Of these funds, 43 were launched in 2023 and 14 of them have not disclosed their target raise yet. Nine funds have launched with a target of $1 billion or more. Twenty-four funds are targeting between $250 million and $1 billion. The remainder, fifty-two are targeting less than $250 million each.
Opportunity for Investors
What this means for investors is there are more and more options to invest in a secured debt position. Some fund managers are investing nationwide while others are focused regionally. Many are focused on residential properties while some are investing in hotel, retail and other commercial product types. It can be difficult to get access to some of the fund managers and more difficult to discern which funds are stronger than others – i.e. which offer a better option to the investor.
This is the first in a series of research about real estate funds, their managers and strategies. Feel free to reach out to the author with any questions or follow up.
John Churchward is Director of Capital Markets for Trueline Capital, a private-lender to the home building industry in the Pacific Northwest. John’s role with Trueline is to expand the company’s capitalization which includes broadening investor relationships. Trueline Capital distributes cash flow to investors, backed by senior, secured positions in brand new residential real estate projects in growing markets. John’s professional real estate career spans 25 years as lender, developer and advisor in the northeast and the western United Sates.