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Building resilience with real estate debt
Direct lenders make loans secured by the underlying real estate assets to experienced real estate sponsors. Lenders have the ability to offer more flexible terms not available in the commercial mortgage-backed securities market.
How does direct lending fit in a real estate portfolio?
Debt’s loan-to-value (LTV) ratio creates an equity cushion, reducing market downside risk in a portfolio. The lender’s likelihood of experiencing a loss is lower than the equity investor’s, who is in the first-loss position. This downside risk mitigation helps explain why debt funds can potentially deliver expected returns even if capital values are falling. The low volatility of capital values and solid income flows mean that the focus of debt investments is resilience rather than growth.
Debt case study: 55 Grand
- 3 industrial buildings
- 9 acres
- 364,000 square feet
- 5 miles east of Manhattan in Maspeth, New York
The business plan was to reposition this class B asset by demolishing two of the 1920s vintage buildings, renovating the remaining building and changing the use from manufacturing warehouse to traditional warehouse. The borrower intended to maximize value by optimizing on-site parking in the area vacated by the demolished buildings.
The sponsor acquired the property in an off-market transaction from the previous owner/operator with a one-year sale leaseback. Shortly after originating the loan, the sponsor executed a 20-year lease with a leading e-commerce company.
A three-year floating rate loan had an initial loan-to-value of 53%. It provided flexibility to upsize the total loan amount, allowing additional advances based on the sponsor executing the lease under agreed lease terms.
The loan upsizing contained favorable lender protections, including loan and interest rate re-margin clauses.
The total fully funded loan size was $100 million, with an interest rate that varied between LIBOR plus 235 and 285 basis points (bps).
The loan was bifurcated between a senior and mezzanine loan, secured by a mortgage on the asset and a pledge of the borrower’s equity interests. Within three months, the senior mortgage position was sold, while the junior mezzanine position was retained at a higher yield. The retained B-note was at a coupon of LIBOR plus 570 bps.
After the lease was finalized and signed, the sponsor repaid the note in full.
55 Grand is a Nuveen debt investment that closed in March 2019. Past performance is no guarantee of future results.
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A word on risk
Responsible investing incorporates Environmental Social Governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well. Real estate investments are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. Please consider all risks carefully prior to investing in any particular strategy. A portfolio’s concentration in the real estate sector makes it subject to greater risk and volatility than other portfolios that are more diversified and its value may be substantially affected by economic events in the real estate industry. International investing involves risks, including risks related to foreign currency, limited liquidity particularly where the underlying asset comprises real estate, less government regulation in some jurisdictions, and the possibility of substantial volatility due to adverse political, economic or other developments.
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