INSIGHTS: Three commercial real estate credit facts worth knowing now
28 November 2022
Commercial real estate (CRE) credit has a range of unique characteristics that can help investors reap the multifaceted benefits of capital security, regular income and portfolio diversification, just to name a few. Here are some of the things you may not know about CRE credit, and how they could help you achieve more of your financial goals.
Fact 1: CRE credit can benefit from rising interest rates
Because CRE credit investments are secured over variable real property loans, they are one investment that can actually benefit from rising rates. As the rates of the loans within a CRE portfolio rise in line with interest rates, these increased returns are then passed onto investors as monthly distributions. In addition, the CRE credit lender can increase their exposure to variable loans when rates are rising. Short-term fixed loans also provide a buffer against rising rates, as the portfolio can more frequently be revalued based on interest rates.
Unlike direct property ownership, CRE loan values do not fluctuate like property values, meaning investors can reap the benefits of the property market without the risks of owning property. The stability of the loan value creates predictable cash flow in the form of regular interest payments from the borrower, which provides income to investors through monthly distributions.
Fact 2: CRE credit provides property exposure without equity risk
Through CRE credit investing, you are able to have exposure to the properties within the portfolio without the risks of owning these properties.
As the chart shows1, debt investments sit lower than equities in the risk-return scale, which is largely due to the fact that private CRE credit allows investors to be on the right side of rising interest rates.
With equity-type investments, the lender has first priority to any cash flows from the property, so as interest rates rise, CRE credit investors benefit from these increasing cash flows.
This is illustrated by the positioning of CRE credit in the repayment waterfall. Senior debt has first security ranking over property, meaning it gets repaid first from the sale of the asset.
Mezzanine debt has second ranking security over property, with the same protections as senior debt and repayment ranking second. However equity – being property ownership – is repaid last after debt repayments.
Fact 3: CRE credit is no longer only accessible by institutional investors
Historically, CRE credit has been an underinvested asset class dominated by institutional investors such as Australian super funds, European pension funds and government sovereign-type funds.
The demand from institutional investors has continued to increase over the years, especially during times of market uncertainty and volatility. The graph shows that more than half of institutional investors expect to increase their allocations by 2025, which will only further drive the growth of this asset class.
While institutional investors have taken advantage of the CRE credit market for decades, it is now becoming increasingly accessible to retail investors through ASX-listed funds.
You can learn more about CRE credit here or simply get in touch today to find out how it might benefit your portfolio.
Notes
1. For illustrative purposes only
2. Preqin Investor Outlook: Alternative Assets H2 2022
Disclaimer
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