In a world of low-to-no interest rates, real estate debt has become very interesting, especially given the COVID-19 crisis. After all, real estate is visible and debt is definable, with an agreed yield to investors. For active managers, the current environment is quite rosy compared with other asset classes.
According to David Maki, a senior managing director and co-head of real estate debt for the US-based specialist manager Heitman, says that, like other asset classes with potentially higher yields, a successful manager will normally need a lot of experience. As it happens, he’s been investing in private real estate debt and other private markets in the US for more than 30 years.
“With any higher- yield and higher-risk investment, the strategy is best executed by teams with experience,” Maki, a frequent visitor to Australia, said from Chicago last week. “In a challenging market and with higher risk loans, an investment manager with the skills to take control of the physical real estate is something we think is absolutely necessary.”
He said: “Real estate debt became increasingly attractive to investors in the later stages of what we can now officially call the “last cycle” since it provides a buffer against asset value declines. Lenders of course have exposure to property value, but any loss of value is first borne by the equity holder, but the loan is at risk.
“With the rapid change in sentiment and repricing of assets across the investment spectrum, we are seeing investors still looking at debt as a way to keep invested in the property market, but maintain protection from value changes. Uncertainty about the path out of the economic consequence of this crisis is making a defensive investment structure attractive again.”
In terms of opportunities for sophisticated investors, to know what the future holds for challenged sectors like retail and hospitality is difficult to assess. “For us,” Maki says, “we are pursuing investments with as many ‘knowns’ as possible. What that means practically are well leased properties, build-to-suit development, and major markets. One of the conventions we now need to consider is what will be the impact on larger metro areas in the US. For example, New York has certainly been hit hardest by this health crisis, but we believe it still represents one of the economic engines of the US economy.”
He says that a metaphor he liked about recovery from the current crisis was that it was more like turning a dial rather than flipping a switch. Things will gradually improve and life will return to its norms. Ever the optimist.
In times of crisis, distressed debt investments have turned out to be very successful. However, Maki takes a philosophical view. He said: “The tag of distressed debt is really more of a way to label returns at a level more typically found in equity strategies. Capital for solving an asset or venture problem is sometimes referred to as ‘rescue capital’, but still carries returns in the “teens” regardless of what it is called. The other way we often think of distressed debt is when loans are being sold to raise liquidity. In those circumstances, it’s common to sell the note at a discount to face value as a way to boost the return needed to attract a buyer. For the seller of the loan, the discount definitely represents a level of distress. For the buyer it is simply an adjustment to reflect current market pricing.
Beau Titchkosky, Heitman’s managing director and head of client service and marketing for Australia and New Zealand, said that in difficult times like this, good and experienced managers tend to come to the fore. “ I’m getting a lot of inquiries from institutional investors in Australia and New Zealand about real estate debt and also real estate equity opportunities both listed and unlisted. We are also about to commence the process of engaging the Australian market looking for Investors who want to put capital to work seeking low double digit returns in USprivate real estate debt – If you liked the thesis pre crisis it’s even more attractive now”
Who was it that said: ‘fortunes are made in the bad times, not the good times’?”
Google’s not particularly helpful with that question. It definitely came from the Great Depression decade and was first mouthed possibly by oil magnate John Paul Getty, politician Joseph Kennedy, founder of value investment management Benjamin Graham or the lesser-known industrialist Floyd Odlum. It’s a good saying. Whoever first thought of it.
Greg Bright is publisher of Investor Strategy News (Australia)