Private debt is a popular alternative to equity investments in the commercial real estate sector. It has encroached on the banks’ primarily syndicated loan market and can provide attractive risk-adjusted returns.
Real estate debt funds make loans to commercial borrowers using privately sourced capital. Investors receive regular interest payments and payment priority of their capital if a commercial property is sold.
Private debt capital is an attractive asset class for real estate investors looking to diversify their portfolios and earn a competitive return. Non-bank institutions, such as business development companies, private equity firms, and wealthy individuals, can issue this type of debt.
A key advantage of debt funds is that their income stream is more consistent and predictable than equity. This is because private debt funds typically offer short-term loans that are senior in a project’s capital stack, meaning they have priority over other types of financing.
In addition, debt funds are incentivized to maximize a property’s value at disposition by improving, stabilizing, or otherwise optimizing the property. This enables the fund to sell the loan to another investor or lender at a higher price, which benefits its shareholders. Private debt funds also tend to have streamlined processes that can get deals done faster than traditional lenders. This nimbleness can be critical for owners and developers that need funding quickly to meet tight closing dates.
As investors’ return streams come in the form of interest payments rather than an uplift in share value, private debt capital tends to deliver higher returns compared to equity. This is especially true for private debt funds focused on commercial real estate.
The higher return on commercial real estate debt capital is primarily because investment returns are not dependent on stock market performance or the timing of mergers and acquisitions (M&A). This non-correlation between asset values and returns is one of the reasons why institutional investors are increasingly deploying capital into private real estate debt.
Personalization and Niche Expertise
Private debt funds often specialize in specific industries or sectors, enabling them to understand the sector's dynamics, risks, and opportunities. Newport Capital executives have decades of commercial real estate experience, including fund management, property acquisition, management, and disposition.
In addition to its broad industry knowledge, Newport Capital has established relationships and networks in private credit financing. Their niche expertise is invaluable to the borrower in providing support and guidance. Newport’s relationship-driven approach to lending can help connect borrowers with strategic advisory services to support their growth.
Private debt capital provides nimble, flexible business financing to meet specific goals. This is especially true for commercial real estate, where the need for rapid closings is common. Private debt funds can often provide the capital required for construction costs, bridge loans, and renovation projects, even when CMBS or agency lenders may not be available.
Private loan funds can also make more granular changes to the loan agreement terms. For instance, they may allow borrowers to convert some loan payments into equity. This aligns the interest of both the sponsor and the lender, creating a win-win situation for all parties.
Private loans can be structured in many ways, including term loans, revolving credit facilities, second-lien loans, and unitranche facilities, combining senior and subordinate debt instruments into one investment vehicle. These types of hybrid-style deals are becoming increasingly popular.
4. Lower Risk, Higher Ownership
When you invest in private debt, your returns tend to come from monthly interest payments and the return of principal. In some situations, debt investors may negotiate a small equity stake or warrant in the underlying company to enhance returns potential and participate in growth as the real estate asset appreciates over time.
Another advantage of private debt financing is the potential for higher leverage. Lenders in private debt arrangements typically rely on the property as collateral, allowing borrowers to secure more significant loan amounts. This increased leverage can provide the necessary funds for property acquisition, development, or renovation while minimizing the need to dilute ownership through equity financing.
Another benefit of financing a commercial property with private debt capital is that it provides lower risk than equity investments. Debt typically sits above equity in the capital stack, so if a borrower declares bankruptcy, debts are paid out first, making them less risky of an investment than equity.
Additionally, many debt funds offer higher flexibility in lending guidelines than banks. They can tailor the loan covenants, repayment schedules, and other conditions to fit the borrower’s requirements. This allows for a more customized lending experience and demonstrates the relationship-driven nature of their approach. As a result, they are better equipped to help bridge companies through challenging times. They can be much more willing to work with borrowers to make granular changes to loan structures that aren’t always available through traditional bank lenders.
Private debt financing can be a more attractive option for borrowers who prefer to maintain privacy and avoid disclosing sensitive business information to a broader pool of equity investors. Debt transactions can be negotiated privately, allowing borrowers to safeguard their proprietary information and retain a higher degree of confidentiality. This is an increasing concern as data is becoming more widespread and shareable across digital platforms in the blink of an eye. Protecting your information is controllable when transacting debt financing, as fewer parties are included in originating the capital.
To Sum It Up
Private debt financing offers greater control, flexibility, lower transaction costs, increased leverage, predictable costs, and enhanced privacy compared to equity financing in commercial real estate. Its personalized approach, niche expertise, advantageous fund structure in predictable and fixed costs, and mitigated risk make it a sounder financing option for borrowers. These advantages make it a compelling approach for property owners and developers looking to optimize their financing strategy and maximize their returns.