Oaktree Capital Management expects real estate capital markets to be more volatile in the year ahead, and it has a war chest to take advantage of the disruption.
The Los Angeles-based firm has closed its third global real estate debt fund on $3 billion, PERE has learned. It has already deployed more than $1.6 billion of that capital and aims to put the rest to work across an array of real estate debt products and direct loans.
With central banks poised to raise interest rates in response to rising inflation, Justin Guichard, co-portfolio manager for Oaktree’s real estate debt and structured credit platform, tells PERE he expects a slowdown in asset appreciation to lead to a deluge of activity as market participants reassess pricing.
“We’re looking for volatility in the midst of that transition that could provide us with attractive returns,” Guichard says. “We have the ability to capitalize on volatility… with the experience and capabilities of the world’s largest distressed debt manager. That will facilitate, hopefully, a positive experience for our limited partners.”
Launched in late 2019, Oaktree Real Estate Debt Fund III is focused on taking advantage of “inefficiencies” in the global real estate market, Guichard says. During the first half of 2020, the greatest inefficiencies were in the securitized debt markets, he states. When traditional buyers of mortgage-backed securities, collateralized loan obligations and corporate debt were forced to sell to pay down margin calls, Oaktree stepped in to buy at discount pricing.
Last year, as transactions and development activity resumed, Guichard says the fund’s capital was used to lend on properties in New York and other markets in the US Northeast, where pricing had become inefficient as other lenders retreated.
“From our perspective, the idea that gateway markets were doomed was faulty and I think that’s largely been evidenced to be the case,” he says. “Try to rent an apartment in New York today. You’ll know I’m talking about.”
In the months ahead, as policymakers attempt to battle inflation – major banks predict the US Federal Reserve Board will raise its benchmark interest rate between four and seven times in 2022 – and capital markets react to those changes, Guichard expects the opportunity set to shift back to securities. Yet, the fund is not tied to any one strategy.
“We are hoping that greater volatility, as rates lift off and perhaps the Fed struggles to manage through this inflationary period, will offer bargains in securities,” he says. “But there’s still plenty to do in private lending today.”
To date, REDF III’s deployment has been focused on the US, Europe and Australia, but Guichard notes that Oaktree is likely to pursue opportunities in the UK – its second largest office is in London – and Asian markets with strong lender protections, such as Japan and South Korea. In total, about 20 percent of the fund will be invested outside the US.
The sweet spot
REDF III surpassed its predecessor by nearly $1 billion. REDF II closed on $2.09 billion in 2018 and similarly was about $1 billion larger than the 2013-vintage REDF I, which closed on $1.1 billion.
Guichard says the vehicles have increased in size in line with the market opportunity, noting that the firm had intentionally kept prior funds smaller. REDF I was about half the size of the firm’s debut real estate debt vehicle, Oaktree PPIP Fund, a 2009 vehicle launched in conjunction with the US Treasury’s Public-Private Investment Program, a $22 billion initiative to resuscitate the MBS market in the wake of the global financial crisis.
“We’re not really focused on growth purely for growth’s sake,” Guichard tells PERE. “But I think, as evidenced by the fact that we’re over 60 percent invested in this fund shortly after our final close, that highlights our team’s ability to find really attractive risk-adjusted returns in today’s market with a sizable pool of capital.”
As of December 31, 2020, Oaktree’s real estate debt business was generating a since-inception gross internal rate of return of 14.6 percent, a net return of 10.1 percent and a gross multiple of drawn capital of 1.2x, according to the firm’s 2020 annual report.
For REDF III, Oaktree secured commitments of $250 million from the Tennessee Consolidated Retirement System, $200 million from the Minnesota State Board of Investment and $100 million from Teachers’ Retirement System of the State of Illinois, according to the PERE database.
“It’s a recognition that we continue to offer to our LPs one of the preeminent strategies globally in this market,” Guichard said of the investor response. “Real estate debt is a sweet spot for a lot of LPs in terms of risk and return.”