Trends Watch: Real Estate Private Lending

January 12, 2023

By Elana Margulies-Snyderman 

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Jan Brzeski, CIO and Managing Director at Arixa Capital Advisors.

What is your outlook for private real estate lending? 

2023 will be a more difficult year for our borrowers – real estate investors and developers who focus on sub-institutional sized residential projects including for sale housing and for rent apartments. They are seeing higher construction costs, much higher interest expense and declining values. For apartment projects, owners who want to refinance out of our short-term loans, and hold the project long-term -- higher rates mean lower proceeds on the take-out loan, so they may need to bring in new capital to be able to hold their properties.

Balancing this out, we still have a shortage of housing, and roughly 2% of all the housing stock in the U.S. becomes obsolete every year, assuming a 50-year average usable life, based on current estimates by Arixa Capital. (This is subject to change based on a variety of economic, non-economic, and market conditions. Different assumptions may yield materially different results.)

In our view, private lending should resume its growth after a period of adjustment and some dislocation in the next 12-18 months.

What are the greatest opportunities you see and why?

In our segment of lending to borrowers who focus on non-institutional projects, I think our industry is still in its infancy. I compare it to fast food in the 1950s. There are plenty of places to buy a hamburger, but nobody has really developed a formula to replicate a very good, consistent experience across many major metro areas. Our competitors are mainly local players that differ from one market to the next.

The greatest opportunity for Arixa is to keep on executing over the next 12 years as we have in the past 12 years, and to not try to grow too fast or try to be a national player overnight. If we strive for every borrower to have a good experience and create an environment where most of them come back to us for their next loan then we believe we will be able to keep distributing steady returns to investors and keep growing.

What are the greatest challenges you face and why?

The challenge for us is the unprecedented rise in interest rates, and the speed with which they have risen. This affects us in two ways: first, it puts pressure on real estate values, which affects our borrower’s profitability, as referenced previously. Second, investors expect higher returns from our private debt funds because their other fixed income options are suddenly offering much higher yield. Even banks are offering 4.5% on some CDs right now. One year ago, 2% would have been considered a very high return for a CD. However, many investors still value what private real estate debt funds have to offer. We’ve made consistent and attractive returns for our investors in the past year, while most investments have delivered sharply negative returns.

What keeps you up at night?

The biggest risk to our strategy is a rapid, large decline in value on the types of properties and locations where we lend. For our typical loan, it would take at least a 25-30% decline in value over a 12-18-month period to lead to principal losses. That’s unlikely on residential properties in major urban infill coastal markets where we lend, but the run-up in values during the COVID-19 pandemic makes a more pronounced and rapid decline more likely than it would otherwise be. Our mantra is to be vigilant, prudent, and protect our track record in the next 12-18 months.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.

About Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.