This article was sponsored by Yardi. It appeared in The Debt Special supplement with the April 2019 issue of PERE magazine.
Virtually anyone can log on to an online 401K account for complete up-to-the-minute information about account performance, because modern technology solutions provide immediacy, accuracy and transparency in investor reporting. Yet, oddly, a level of reporting that includes those three vital elements remains a rare commodity in one of the fastest-growing segments of the commercial real estate capital markets: debt fund investment. Also lacking in the communication between investor and fund manager is a holistic view of the commercial real estate debt market that provides the backdrop for fund manager performance, so it is good news that supporting technologies are now emerging to keep pace with the growing number of fund investors’ demand for transparency and communication that far exceeds the traditional 90-day reporting window on which the industry was built.
That the real estate capital markets are evolving at an accelerating rate is a given. So it is with sources of debt, as more players enter the arena against the twin backdrops of a shifting lending picture and late-cycle economic dynamics.
Debt is taking on a dramatically expanding role in real estate, particularly for services like construction financing and loans on transitional properties. Debt fund originations have climbed steadily over the past few years, from $32 billion in 2016 to $67 billion in 2018, according to data reported in February at the Mortgage Bankers Association’s (MBA) annual commercial real estate finance convention in San Diego. That rising profile is noteworthy at a time when overall originations remain robust but basically unchanged from year to year. MBA estimates that originations will total $530 billion in 2019, similar to 2018 ($526 billion) and 2017 (a record $530 billion). Last year’s total accounted for 10 percent of total mortgage origination with some 140 debt funds currently plying their trade. On closed-end funds alone, some 70 vehicles were actively pursuing deals or raising capital in the US in 2018, Real Estate Alert noted. That represents a significant jump from the 49 that were active just four years ago.
There are several reasons for the ascendency of debt funds. Abundant capital, domestic and foreign alike, is looking to invest in US real estate. On the theory that a rising tide lifts all boats, that bodes well for all categories of lending. The twist is that many major conventional sources of real estate capital — notably, commercial banks — face increased regulatory scrutiny. New rules aim to restrict lending on real estate assets regarded as high risk and require lenders to have more skin in the game. Not surprisingly, some lenders have cut back on certain types of lending, raising the visibility of other debt sources, despite their relatively higher cost of capital.
“The market is ready for systems that will bring the debt investor and manager together in a synergistic way”
Debt funds are among the chief beneficiaries of this trend, which is largely a function of this late phase in the economic cycle. Not that a downturn is expected anytime soon, but the consensus among investors is that debt can match, or nearly match, the yield of equity without sweating as much risk.
Of course, if there is a downturn, it will be bad for all concerned, and we can never discount a quick shift in the investment landscape. One need only look at the upheavals in the retail market to get a sense of how vital it is to stay on top of market shifts – and how volatile the market can be.
Tech is answering the call
In a late-cycle environment of accelerating change, investors’ expectations of accurate, timely and transparent reporting from fund managers is also evolving rapidly. Technology must step into this breach, frankly, because the quarterly reporting upon which the industry was built no longer seems fast or transparent enough.
At Yardi, we hear that call with increasing frequency from investment clients seeking assistance in managing debt funds as an asset. Whether they are increasing their debt positions or starting funds themselves, investors are looking for reliable tools to help them gauge their exposure to every adjustment of the market. More than ever, investors want timely insights into how the latest real estate news will affect their dealings with managers.
Products addressing that issue are available, but to the extent that the goal of those products is solely debt fund management, the picture is incomplete. Crucially, these investors also want another dimension: sophisticated, timely reporting of performance and other information. It is the kind of visibility that they can already find in other realms, notably in the securities environment. That degree of self-service access and understanding is now migrating into commercial real estate.
Providers of accounting capabilities for core real estate must bring their experience to the debt space. With that in mind, Yardi is partnering with a select group of clients that share a strategy of taking an expanded debt position. The exercise is part of the preparation for debuting a more holistic version of debt management software later this year. The creation of debt management software is a natural evolution of our experience managing debt as an asset in the trust accounting space. The market is ready for systems that will bring the debt investor and manager together in a synergistic way.
The continued growth of debt fund activity is as close to a sure bet as one can get in the real estate capital markets. As growth accelerates, the tools for effective, real-time analysis of fund performance become ever more essential. Debt fund managers are their investors.