If you’re in the private equity and real estate (PERE) game, you may have noticed that major players like Blackstone, Cerberus Capital Management, and Berkshire Residential Investments are showing up a lot more frequently. The reason for this has to do with the current market’s temperature.
As of now, there is high risk, high interest, and a high possibility of economic disruption within the PERE market. General partners (GPs) and limited partners (LPs) tolerate all three of these factors better than traditional lending institutions. As a result, real estate debt funds are aggressively raising capital even as traditional lenders move away from the market.
Moving into the second half of 2023, real estate debt funds will be a great way to close PERE deals — and an excellent place for GPs and LPs to park their money.
Traditional lenders have backed away from real estate
Due to generalized concerns about the economy and rising interest rates, big banks have been pulling back on private real estate investments. Additionally, many lenders blitzed through their capital, investing in real estate when interest rates were low. These lenders have a lot of invested capital at risk and don’t want to further increase their exposure.
But PERE dealmakers are undaunted by these market conditions. Many GPs, LPs, and institutional investors believe there are still opportunities within the real estate market — and they need lenders to fund them. Real estate debt funds are a fast, effective, and agile alternative to traditional lending.
Even when traditional lenders aren’t scared, real estate debt funds can present borrowers with significant advantages over traditional lending. Real estate debt funds offer more flexible terms and close quickly.
Alternative lenders can finally compete with traditional banks
When interest rates were low, alternative financing — such as a real estate debt fund — was much more expensive than traditional financing. Conservative real estate investors only took advantage of alternative financing if they couldn’t get a loan from a traditional lender, usually because the investment was deemed high risk. Now, interest rates have risen high enough that the costs of alternative lending can compete with traditional lending.
Traditional lending will continue to be expensive as long as the Federal Reserve maintains high interest rates, whereas alternative lenders have a lot of flexibility in how they set their interest rates and terms. Alternative lenders can also lend money faster because they only need to meet their own internal requirements, which is important when time-sensitive deals arise.
The demand for PERE loans outpaces supply
Traditional banks are pulling back, and real estate debt funds are eager to fill the gap. Even with the increase of real estate debt funds, there are still far more traditional banks than private real estate investors. And despite the high interest rates, the real estate market continues to grow. Alternative lenders cannot completely meet the demand because there are so many commercial real estate borrowers that still need lenders.
As part of diversifying their funds, most institutional investors continually shift their investments to whatever they consider the most promising at the time. Now, investors are looking at real estate more than ever before — because that’s where there’s a need for funds.
In short, even with the recent proliferation in real estate debt funds, there is still a demand for more. As long as private equity invests in real estate, this demand will continue.
LPs and GPs remain optimistic about real estate
want to participate in the real estate market, and investing in real estate debt funds allows them to do so. LPs and GPs may decide to invest in real estate through a real estate debt fund rather than through direct acquisitions — or they may do both to expand their diversification.
Despite reduced mortgage lending (driven in large part by the skyrocketing interest rates), the real estate bubble hasn’t popped. In some situations, high interest rates can be good: cash buyers are dominating the market and will likely continue to do so as prices go down.
For those who believe the real estate market will bounce back, this is essentially a sale of real property. Private may seek to invest in rental properties, for instance, as residential property values decrease. may seek to invest in office space if they believe that leases will ultimately rebound.
Even a recession — which many believe is on the horizon — could present real estate debt funds with the opportunity to purchase discounted properties. Many investors still believe that formerly safe bets, such as commercial real estate and multifamily properties, are likely to make a comeback.
Real estate debt funds are less risky than direct investing
A real estate debt fund spreads risk over many investors. To satisfy the fund, the debt must meet criteria set by every single investor. Each investor does their own due diligence, and origination doesn’t proceed until they are all satisfied. Consequently, those who want to park their money in a (relatively) lower-risk investment are now looking toward real estate debt funds.
Having shared risk doesn’t just mean investors are less likely to lose money; it also increases liquidity. Investors can withdraw their investment during recapitalization, choosing to cash out rather than stay in. Most investors crave liquidity during turbulent economic times, and many still fear a recession. During a downturn, an agile investment strategy advances the best outcomes.
Not only does a real estate debt fund make it easier to pull out of a bad real estate asset, it also unlocks liquidity so you can take advantage of other potentially lucrative opportunities.
Get a head start on PERE dealmaking with DealCloud
Real estate debt funds can facilitate PERE deals — and they’re growing more attractive every day. LPs and GPs looking to fund or originate deals should consider real estate debt funds as an alternative to traditional lending or direct investing.
Still, as with any corporate real estate investment, due diligence is critical. DealCloud makes it easier to conduct thorough due diligence and push deals and investments through your pipeline.
DealCloud offers numerous capabilities to support PERE dealmakers:
- Use DealCloud’s third-party integrations and DataCortex to collect information about potential deals. Find out more about other investors, companies, and properties, so you can make educated and timely risk assessments.
- Automate and streamline your real estate fund management using DealCloud as a centralized and consolidated resource. DealCloud is purpose-built for finance and real estate, providing all the tools you need for portfolio management, asset management, investment management, and more for those on both sides of real estate loans.
- Increase the accessibility and agility of your fundraising and investor relations when scoping out new deals. DealCloud’s relationship management helps you source deals, connect with LPs and GPs, and analyze your firm’s activities and initiatives.