Is private debt currently one of the best opportunities for cautious investors?
Sensible investors should continue to expect volatility over the remainder of this year, since the list of unknowns is still long.
What will happen on November the 3rd in the US elections? What will the final outcome of the Brexit negotiations be and will the UK secure meaningful trade deals elsewhere? How will the rising global tensions with China play out and what opportunities may this situation present? Is positive sentiment keeping the markets afloat, and if so, then how quickly can sentiment change?
With equities reaching record highs, some investors see only limited upside potential. At the same time a persisting low interest rate environment makes traditional fixed interest investments unattractive. This has led to a surge in interest in investment opportunities that offer more attractive risk-adjusted returns.
One of the asset classes that offers the most attractive risk-reward profile is private debt.
Following the last financial crisis, a funding vacuum was created due to stricter banking regulations that restricted the amount of funding traditional banks were providing to small and medium enterprises. The direct lending industry continues to benefit from this and has seen spectacular growth. This growth is expected to continue, with Blackrock predicting returns on direct lending over the next seven years to average 10.4% per year.
The only asset class with a higher expected return is private equity, expected to return 10.8% per year over the same period. However, private equity has a completely different risk profile. Private debt also needs to be considered more closely when looking from a cautious approach. Some forms, such as venture debt and subordinated loans would probably not meet the risk profile of a cautious investor. These investors should be looking for opportunities in the secured lending market where they benefit from the strongest protection. For this reason, we think the UK real estate bridge lending market is by far the most attractive area of private lending.
What are real estate bridging loans?
Real estate bridge loans are short-term loans that are fully secured by the value of a property. Following a valuation of the property from an independent valuer, the loan provider obtains a legal charge over the property that enables them to force the sale of the asset in case the loan is not repaid. To improve this security further, most companies will not issue a loan that is more than 75% of the value of the property, so the property value would have to decrease more than 25% to present any kind of risk.
The UK is by far the biggest bridging market in Europe with a well-established legal framework and strong lender protection. According to the Association of Short-Term Lenders, UK bridging loan books grew 19.7% to £4.5 billion in 2019, which is more than the combined market size of all other European countries.
What are the reasons real estate developers are willing to pay such high rates?
A recent study by EY found that the key consideration when choosing a bridge lender, is the speed of execution. The most common use of a bridge loans is for refurbishment projects with a relatively short duration. Another reason is an acquisition bridge to complete the necessary down payment within 30 days after purchasing a property at an auction. Developers might also seek bridge funding to start a development before replacing the bridge loan with a cheaper construction loan or mortgage by a bank. Sometimes, a partial construction or a certain level of pre-sales help to get a more favorable long-term bank loan, which more than offsets the temporary high rates for a bridge.
What are the benefits to investors?
Bridging loans have durations anywhere between 3-24 months, so investors benefit from the short duration of the bridge loans and clear exit strategies. As mentioned before, the loans are secured against the value of the property and the lender has a legal charge over the property which means they can take control of the asset should they need to. Investors can count on best-in-class valuation companies that ensure a fair, current appraisal of the properties before a loan is given.
How can I invest in this asset class?
We have researched the market extensively and partnered with an industry leader in the bridging loan market. They have been able to create an investment process and structure that is already familiar to our clients. Each investment is set up as a Bond between the investor and the company.
The bond pays a fixed return per year, with interest paid monthly. On a 1-year term the bond will pay 4.5%. On a 2-year term, 4.75% and on a 3-year term 5% a year. In the current climate it is understandable that many people will want to steer clear of equity-based investments, however, sitting on cash and watching it being eroded by inflation is frustrating. Other fixed return investments are still high risk or not offering attractive yields, so for the cautious investor that is concerned by the potential volatility in the near future, we think this is an option that offers fantastic protection.
For more details on this type of investment, the company behind it and how to move forward if you are looking for an investment that mitigates volatility, complete the form below and one of our team will get in touch.