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The ‘sweet spot’ for commercial real estate debt in client portfolios

For capital allocators concerned about exposing their clients to too much risk in real estate debt, specialists say asset discernment and due diligence are key to protecting investments in a rapidly growing sector.

As questions swirl about the impact of higher rates on the rapidly growing private real estate debt market, capital allocators are facing a new anxiety: are they really assessing risk correctly, or steering clients towards the iceberg? The reality, according to practitioners, depends on the credit, so due diligence is key.

At The Inside Network’s recent Alternatives Symposium, Pitcher Partners managing director Charlie Viola asked a panel of specialists in commercial real estate debt some frank questions about the sector’s outlook and how advisers can be sure they’re safely investing their clients’ money.

A key part of the answer, according to Sameer Chopra, head of CBRE’s Pacific research team, is that every piece of real estate is very different. Due diligence should therefore be an essential part of the investment process.

  • As for the broader economic outlook for the sector, Chopra was optimistic. “When the market’s the worst, that’s when I’m most greedy,” he said – in other words, the high level of concern around property markets will translate to opportunities.

    “That’s why I was most greedy around residential in November last year, when everyone was talking about the fixed-mortgage cliff,” he said, adding that the uncertain environment has made CBRA a buyer. “People hate office right now, and I’m getting greedier.”

    Pallas Group executive director Craig Bannister (pictured, speaking) agreed that the “nuances around the property market are huge” and depend heavily on asset type and location. Pallas’ approach hinges on assessing the credit risk under each loan and monitoring throughout the loan process.

    “It’s not like I’m going to give a borrower money today and expect it back in 12 or 18 months and there’s no chats,” he said. “It’s monthly and weekly chats; it’s us going out to site, seeing construction sites and talking to subcontractors, finding out if they’re getting paid.”

    He acknowledged that the last 18 months have been extremely challenging for lenders, tougher even than the GFC. “But being so close to the borrowers, monitoring the loans, understanding when something goes wrong, and being able to adjust and help them has been our key elixir, the way we get that borrower through.”

    ‘Safe and steady’

    Viola asked how allocators can avoid getting overexcited by private debt, given the equity-style returns it’s producing. Troy Swann, chief investment officer at Evidentia Group, said the appropriateness of these investments depends on the client, with higher allocations more suited to those with longer time horizons and more capital, while the liquidity constraint can be problematic for pension clients.

    “One qualification is, for smaller clients with balances below $1 million, we would say not to go near this at all.”

    Bannister agreed there’s no need to play a riskier curve to most clients, given the attractiveness of first-mortgage debt. In contrast, the second-mortgage space is for wealthier clients, while preferred and ordinary equities aren’t for most clients looking for a safe income stream – in short, “safe and steady at first mortgage is the sweet spot”.

    For his part, Viola said he believes investing in commercial real estate still makes sense, but it’s important to understand the difference in the absolute rate of return.

    “Then, you have to just trust the jockey – but be comfortable they’re able to do the due diligence and get the credit assessment right.”

    Lisa Uhlman

    Lisa is editor of The Golden Times and has extensive experience covering legal and financial services news.

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