This article was co-written by Gaultier Saussine, Partner, KPMG Luxembourg.
In the ever-shifting landscape of investment opportunities, debt investments stand out as versatile instruments catering to a myriad of investors. Amid soaring inflation and interest rates, some asset managers are considering leveraging the distressed sales of real estate assets by acquiring debt, rather than directly investing in these assets.
Additionally, given the ever-changing nature of real estate lending, opportunities may arise around refinancing existing debts, with traditional banks less eager to risk exposure during tumultuous times.
In our recent article about private debt, we noted this situation has given rise to one of the most extraordinary times for private credit investors across our 20-year track record. It’s phenomenal to have nearly all credit structures at floating rate in a climbing rate environment, as long as the right businesses are lent to.
Why invest in real estate debt funds?
Real estate debt funds are attractive propositions for investors seeking stable returns with lower volatility. They also offer more security than equity investments, as lenders often have priority in case of default. They’re a way of taking part in the real estate market while minimizing some of the risks of property ownership.
However, these funds can be sensitive to interest rate changes. When interest rates rise — which seems less likely at this point of the cycle — borrowing costs for real estate projects can follow suit, affecting these investments’ profitability. Investors should be aware of these funds’ exposure to interest rate fluctuations and consider how this may affect their overall performance.
On the other hand, real estate debt funds have many positive features. For starters, the investments are subordinated and offer a regular interest yield. And as a backup in a worst-case scenario, such as default or financial difficulties, these funds can take over and manage the underlying assets, thereby creating additional value.
Market player insights
Investing in debt funds is an appealing strategy if you’re seeking higher yields, as investments through debt can match private equity returns while outperforming real estate property results. Typically, the loan-to-value (LTV) ratio will have a significant cushion, while you additionally benefit from a larger yield from the interests paid.
Private versus public debt: from an investor point of view
In recent years, we’ve seen significant bond issuances by various real-estate players in Europe to invest in pan-European markets.
These public debt instruments are structured to receive the loan receivables directly. This means the public entities are regulated by various authorities and must extensively report on their key transactions to the market. However, it’s important to note they generally provide lower yields than private debt instruments.
This isn’t to say private market players don’t accurately report to the market — they do. However, they’re usually unregulated, and their yields are often higher.
