Trends Watch: Private Debt Investing

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 Nels Stemm, Principal, Fairview Partners.

What is your outlook for private debt investing?

The current opportunity set in real estate debt is very attractive and we expect it to become even more favorable throughout 2023 and beyond. There is over a trillion dollars of commercial real estate debt which is maturing in 2023 and 2024. However, unlike the often referenced “wall of maturity” of the last decade, these currently maturing loans are facing the highest interest rates in several decades, rather than some of the lowest. We think the difference in results will be very significant.

These maturities are the backdrop for a number of bespoke challenges that the real estate market faces via product type, market, and specific capital constraints. We foresee a large number of opportunities arising for flexible and opportunistic private capital – whether for borrower-driven goals or lender loan sales. The distress cycle has already shown signs of picking up, and there will be a great need for strategic investment capital and active investment management that can help resolve distressed situations by managing bankruptcies to a satisfactory conclusion, or (more preferably) that can craft workouts to avoid them in the first place. However, we expect that supply of this flexible investment capital will be limited, especially for small and mid-balance loans, as investing safely in this space requires expertise in navigating the complex issues common to distressed credits and special situations as well as very active asset management.

What are the greatest opportunities you see and why?

We see tremendous opportunities coming to purchase heavily discounted distressed and stressed real estate debt in the secondary market. The fundamentals of many borrowers have already declined significantly. Meanwhile, lenders are finally starting to see greater funding pressure. For the first time in over a decade, banks are having to compete for deposits, which increases their willingness to sell loans which are now more expensive for them to hold.

We also see opportunity in originating high-yield real estate debt. The rest of the debt markets are starting to catch up in price with the kind of expensive terms we offered throughout the credit boom, increasing our competitiveness in the current market.

What are the greatest challenges you face and why?

Our current primary challenge is to raise enough capital for the opportunities we are presented with. One reason is because, as an alternative investment manager with a niche and less conventional investment strategy, we are less well-known amongst allocators and require a more educational approach as to what our strategy can offer to high net worth and registered investment advisor (RIA) investors’ portfolios. In addition, when our opportunity set is most attractive, investors tend to be more restrained in their deployments of capital due to drawdowns in other parts of their portfolios.

We prefer to use minimal leverage in our program which allows us to focus on serving more unconventional parts of the finance market to achieve our desired risk/reward profile. The practical impact of a low-leverage model is that we do not have a strong multiplier effect on the dollars we raise.

Finally, every investment we make is fairly unique and thus investors must be comfortable with our discretionary investment program. This is in contrast with other alternative private credit funds that use more conventional rules-based finance programs. They are often dependent on high leverage, which limits their ability to participate in many of the underserved gaps in the lending market that we actively pursue. We believe we earn our alpha with our less conventional, more active strategy, but it can be a challenge to educate investors on these points.

What keeps you up at night?

We set up our company in 2011 to focus on investing in distressed real estate secured debt. We did so with deep consideration of our existing financial system, forecasting that we would see multiple significant distress cycles to invest into and that our portfolio of secured debt would perform better than alternatives, such as equity, when distressed cycles emerge.

This forecast is based on my greatest financial fear: Our debt-based monetary system unwinding. We live in a world where there is no such thing as cash, but rather higher and lower grades of debt. Whether that debt is Treasuries, bank deposits, the “money market,” etc. – it is all based on the credit of others.

Eventually, those inter-dependent credit relations, and the systemic leverage they represent, can unravel. Widespread investment losses would be bad enough, but if those investment losses hit assets which are regarded as “cash,” real lasting damage would take place. I believe that is the greatest fear any investor today should have: the very concept of cash being called into question.

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