Commercial real estate debt is generally considered as an attractive investment as it is able to combine stable income returns with a relative level of downside protection because of foreclosure rights on real property. Furthermore, US CRE debt is an immense market ($4.7 trillion of outstanding commercial mortgages), thus allowing investors depth, liquidity and strong risk-adjusted returns. CRE debt funds aim to generate returns for investors by investing in commercial mortgages and mezzanine debt and have been gaining prominence in recent years.
In 2021, the top 50 debt funds raised $190 billion, with the top 5 funds (AXA, Blackstone, PAG, PGIM and Cerberus) accounting for 31% of the capital raised. Debt funds totaled 7% of all capital raised in 2016 and increased to 12% in 2020. These statistics clearly demonstrate that debt funds are becoming increasingly popular than typical commercial bank loans. While banks have a cheaper cost of capital and lower interest rates, they are also more inflexible with loan terms and typically focus on stabilized properties with high occupancy. Meanwhile, debt funds help fill the financing gap for riskier assets where debt funds can achieve higher returns. This gap left by banks has allowed the debt funds sector to flourish.
The growth of debt funds is due to both cyclical and secular forces. Some investors argue that debt funds are a good late-cycle play; when the market is reaching a low, debt can produce almost the same yield as equity with less risk. Another contributor to the growth of debt funds is the great amount of capital flowing into commercial real estate. It is a great way to get large amounts of capital invested quickly in the sector and also meet return expectations. Overall, CRE debt funds have outperformed corporate bonds by 540 BPS annually and have compared favorably to other assets. CRE debt in the US has been increasingly sought after by pension funds and other institutional investors.
Will CRE debt funds continue to see strong growth and gain more market share?
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