Most of the loans are first mortgages – that is, they have the first call on the property in the event of default – but some loans returning 8 percent are mixed with mezzanine debt that ranks lower after default. These are attractive yields compared to bank rates as well as yields for commercial property itself – around 4-5 percent for office and industrial properties.
CRE debt is becoming an increasingly attractive option for sophisticated investors and some mom and dad investors with $100,000 to $500,000 to allocate. Non-bank lenders have a combined loan book of approximately $35 billion.
Although it is possible to invest in single loans, most investors put their money in an unlisted fund with a spread of loans, which helps mitigate risk.
Companies such as La Trobe Financial, MaxCap, CVS Lane, Pallas Capital and Qualitas offer commercial real estate debt funds to investors, while Merricks Capital offers finance with loans for agricultural properties.
Be aware of the downside
Qualitas, for example, has a range of CRE debt funds, including the Qualitas Senior Debt Fund and the Qualitas Construction Debt Fund, where loans are secured against the land or real estate soon to be or already under construction.
As attractive as the yields are, there are downsides to CRE debt.
The preservation of capital comes at the price of capital growth, so the investor does not participate in any property price appreciation during the term of the loan.
It’s also worth noting that some lenders offer more generous loan-to-appraisal ratios than banks and loans with fewer conditions, such as less or no pre-sale for developments. These increase the yield but also the risk.
The investor’s money is also locked away for the duration of the loan, usually one, two or three years and sometimes up to four years. However, this could be an attractive option for those who want to park money to avoid global market volatility and still earn a good return.
The default risk on these investments is low, but that could rise if the economy slows and unemployment rises.
Along with the equity buffer, investors can gain additional comfort about the safety of their investments by asking a few questions of the issuers.
They should inform themselves about the underlying assets backing the loan and get advice if they do not have a solid understanding of the asset class or geography.
Another question is the fund manager’s experience and track record, how many of their previous funds have failed and whether they have a long-term track record of returning money.
Finally, there is the structure of the loans themselves, whether there is enough equity to protect investors and if the borrowers have put up personal guarantees, such as their homes.