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Real Estate Debt Funds in Commercial Real Estate
For commercial real estate borrowers, debt funds often offer loans that banks can’t-- or won’t offer, including commercial construction loans, bridge loans/lease-up financing, and certain property rehabilitation and redevelopment loans. According to the Mortgage Bankers Association (MBA), debt funds originated nearly $70 in billion commercial real estate loans in 2018, around 10% of all CRE loans originated in that year.
- The Role of Debt Funds in Commercial Property Financing
- Why Debt Fund Financing Has Become Increasingly Popular
- How Debt Fund Loans Work for Commercial Construction Borrowers
- The Largest Debt Funds Closed Between 2008-2018
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The Role of Debt Funds in Commercial Property Financing
For commercial real estate borrowers, debt funds often offer loans that banks can’t-- or won’t offer, including commercial construction loans, bridge loans/lease-up financing, and certain property rehabilitation and redevelopment loans. According to the Mortgage Bankers Association (MBA), debt funds originated nearly $70 in billion commercial real estate loans in 2018, around 10% of all CRE loans originated in that year. That’s more than twice the $32 billion of commercial mortgages originated by debt funds in 2016. While some debt funds are operated by private equity firms, others are available for investment by the general public. Much like commercial mortgage backed securities (CMBS), debt funds are generally organized into tranches based on the credit risk of various groups of loans.
Why Debt Fund Financing Has Become Increasingly Popular
Debt funds first became a popular source of commercial financing during the 2008 financial crisis, when banks were no longer able to offer commercial loans to many borrowers due to serious liquidity issues. As a result, private lenders saw an opportunity to profit from filling a much-needed market niche. While banks, CMBS, and agency lenders have long since returned to offering acquisition and refinancing loans for stabilized properties, many still do not offer construction loans or bridge loans-- and that’s where debt funds come in. Even if a commercial borrower can identify a suitable lender for their situation, debt funds can often move much faster than other lenders, which can be essential when time is a factor in closing a deal.
In addition, a boom in the market for collateralized loan obligations (CLOs), allows some debt fund firms to more easily securitize and sell their loans. In 2018, 19 companies issued nearly $15 billion of CLOs, nearly double the amount of CLOs issued in 2017.
How Debt Fund Loans Work for Commercial Construction Borrowers
Most debt fund construction loans are offered to borrowers at somewhat lower LTVs than comparable bank loans; for instance, while a bank may offer 70% LTV for a purchase loan, a debt fund may only offer 60% loan to cost (LTC) for commercial construction financing. In addition, just like most other kinds of construction loans (including construction financing for single-family homes), debt funds issue money to borrowers in multiple disbursements, with each disbursement being issued only after the previous stage of work on the property is complete. Since most debt fund loans are for commercial construction or rehabilitation, the average loan term is usually between 24 and 36 months, with interest rates generally ranging between 10-12%.
For larger construction loans (i.e. $30 million+), debt funds are often willing to increase leverage up to 80% LTC, as well as decrease interest rates to between 7-8%. On loans of this size, borrowers may be able to get lower rates by reducing leverage. Generally, these larger loans are relatively low risk, as far as construction lending goes, and simply do not fit in with the lending parameters of many commercial banks.
The Largest Debt Funds Closed Between 2008-2018
Traditionally, debt funds open during a specific period, during which loans are issued and pooled together in the fund. Afterward, the fund closes, continuing to provide income for investors, but no longer issuing new debt. To give you an idea of the size and major players in the debt fund space, we’ve included a list of the largest North America debt funds that closed between 2008-2018.
Broad Street Real Estate Credit Partners III: Created by investment banking giant Goldman Sachs, this debt fund has a size of $6.7 billion.
PIMCO Bravo Fund II: Operated by Pacific Investment Management Co. (PIMCO), this fund has a size of $5.5 billion.
Blackstone Real Estate Debt Strategies III: Created by The Blackstone Group, the largest alternative investment firm in the world, Blackstone Real Estate Debt Strategies III contains $4.5 billion of commercial debt.
Broad Street Real Estate Credit Partners II: Also issued by investment banking firm Goldman Sachs, this debt fund is slightly smaller than its larger counterpart, with a size of $4 billion.
AllianceBernstein Commercial Real Estate Debt Fund III: Created by NYC-based investment firm AllianceBernstein, AllianceBernstein Commercial Real Estate Debt Fund contains $3.1 billion in commercial debt.
What is a real estate debt fund?
A real estate debt fund is a pool of capital that is used to finance commercial real estate loans. Debt funds typically offer loans that banks can’t-- or won’t offer, including commercial construction loans, bridge loans/lease-up financing, and certain property rehabilitation and redevelopment loans. According to the Mortgage Bankers Association (MBA), debt funds originated nearly $70 in billion commercial real estate loans in 2018, around 10% of all CRE loans originated in that year. That’s more than twice the $32 billion of commercial mortgages originated by debt funds in 2016.
Traditionally, debt funds open during a specific period, during which loans are issued and pooled together in the fund. Afterward, the fund closes, continuing to provide income for investors, but no longer issuing new debt. To give you an idea of the size and major players in the debt fund space, some of the largest North America debt funds that closed between 2008-2018 include:
- Broad Street Real Estate Credit Partners III (created by investment banking giant Goldman Sachs, size of $6.7 billion)
- PIMCO Bravo Fund II (operated by Pacific Investment Management Co. (PIMCO), size of $5.5 billion)
- Blackstone Real Estate Debt Strategies III (created by The Blackstone Group, size of $4.5 billion)
- Broad Street Real Estate Credit Partners II (also issued by investment banking firm Goldman Sachs, size of $4 billion)
- AllianceBernstein Commercial Real Estate Debt Fund III (created by NYC-based investment firm AllianceBernstein, size of $3.1 billion)
Debt funds are an increasingly promising option for borrowers seeking commercial financing, especially those looking for construction and bridge loans for somewhat higher-risk properties.
What are the benefits of investing in a real estate debt fund?
Investing in a real estate debt fund can offer a number of benefits, including the potential for higher returns than other types of investments, diversification of a portfolio, and the ability to invest in a variety of loan types. Debt funds can offer higher returns than other types of investments because they are often secured by real estate, which can provide a higher level of security than other investments. Additionally, debt funds can provide diversification to a portfolio, as they can be invested in a variety of loan types, such as commercial construction loans, bridge loans, and property rehabilitation and redevelopment loans. Finally, debt funds can provide access to a variety of loan types that banks may not offer, such as construction loans and bridge loans.
What types of investments are included in a real estate debt fund?
Debt funds generally include investments in commercial construction loans, bridge loans/lease-up financing, and certain property rehabilitation and redevelopment loans. According to the Mortgage Bankers Association (MBA), debt funds originated nearly $70 in billion commercial real estate loans in 2018, around 10% of all CRE loans originated in that year. That’s more than twice the $32 billion of commercial mortgages originated by debt funds in 2016. While some debt funds are operated by private equity firms, others are available for investment by the general public. Much like commercial mortgage backed securities (CMBS), debt funds are generally organized into tranches based on the credit risk of various groups of loans.
Source SourceWhat are the risks associated with investing in a real estate debt fund?
Investing in a real estate debt fund carries a number of risks, including the risk of default, the risk of illiquidity, and the risk of market volatility. Default risk is the risk that the borrower will not be able to repay the loan, which could result in a loss of principal for the investor. Illiquidity risk is the risk that the investor will not be able to sell the loan or the security backed by the loan in a timely manner. Market volatility risk is the risk that the value of the loan or security will fluctuate due to changes in the market. Additionally, debt funds may also be subject to regulatory risk, as they are subject to the rules and regulations of the jurisdiction in which they operate.
What are the tax implications of investing in a real estate debt fund?
Investing in a real estate debt fund can have a variety of tax implications, depending on the type of fund and the investor's individual situation. Generally, debt funds are subject to the same tax rules as other investments, such as capital gains taxes. However, investors should be aware that debt funds may also be subject to additional taxes, such as the Unrelated Business Income Tax (UBIT).
It is important for investors to work with a qualified tax professional to understand the potential tax implications of investing in a real estate debt fund. A tax professional can help investors understand the tax rules and regulations that apply to their individual situation, as well as any changes to the tax code that may affect their investments.
How can I find the best real estate debt fund for my investment goals?
The best way to find the best real estate debt fund for your investment goals is to research the different debt funds available and compare their terms, fees, and returns. You can find information about debt funds on websites such as CommercialRealEstate.loans and Investopedia. Additionally, you can consult with a financial advisor to help you find the best debt fund for your investment goals.
While these funds are all currently closed, numerous debt funds are being created each year by large and mid-sized firms alike. And, though debt fund loans are mainly a tool for a very specific type of commercial real estate borrower, some companies are considering branching out, meaning that they could soon competing with banks for traditional commercial acquisitions and refinancing. In addition, increased competition between debt funds is leading to a reduction of spreads across the board. All this means that debt funds are an increasingly promising option for borrowers seeking commercial financing, especially those looking for construction and bridge loans for somewhat higher-risk properties.