by David Drake
Debt financing is emerging as a key strategy for private equity firms. In 2014, a significant number of private equity firms moved their capital to debt investments with no signs of slowing down in 2015. By the end of the first quarter of 2015, a total of $20 billion had been raised by 25 debt funds. According to Preqin, a research firm based in London, real estate debt capital raised from 26 debt funds across the globe in 2014 amounted to $20.4 billion, up from $15.7 billion raised by 29 debt funds in 2013.
Torchlight Investors managing director and partner, Bill Stasiulatis, says private equity firms are increasingly finding the capital raising market more favorable due to the healing that has happened in the past 3 years. In 2013, Bill’s firm raised close to $1 billion during its 4th debt opportunity fund and launched its latest fundraising effort early 2015 with the aim of raising some $1 billion. Here are seven reasons why private equity will challenge debt financing in real estate in 2016:
1. Debt financing from private equity is on the rise
Walker & Dunlop (commercial realty financing solutions provider) Senior Vice President Neil Bane acknowledges an increasing number of private equity firms are getting into debt financing. This shift originally started when influential players such as Colony and Blackstone Capital offered investors looking to purchase single-family homes with debt financing. The market has grown to a level where private equity companies are now offering various types of properties capital and also acquiring land for development. Recently, Blackstone provided $102 million in debt financing to finance the $200-million-worth Miami’s Hyde Resort and Residences project. In a separate deal, Canyon Capital gave a $157-million construction loan to an SBE Hotel Group and Florida’s Related Group joint group for the construction of SLS Brickell Hotel and Residences.
2. Private Equity firms earn more through debt
A key reason why private equity firms are opting to invest in debt is the fact that some of the structured debt finance products are generating similar yields as equity. President of Debt & Structured Finance Global, Brian Stoffers says these products become extremely appealing once their risks have been adjusted. Some debt investments can generate double digit yields when the entire loan is taken down and a residual or a piece is sold off. Debt investments are also increasing yields through purchase of non-performing or sub-performing loan portfolios. Reworking mortgages increases yields and gives private equity firms handsome returns. Also, debt financing relating to bridge and mezzanine loans provides high yields.
3. Private equity firms can raise huge capital
Unlike debt financing where real estate developers need to raise funds from different investors to reach the targeted amount, private equity firms have a demonstrated ability to raise huge amounts of capital that most developers in the real estate sector require. For instance, Blackstone Capital Group alone has already raised billions of dollars, an element that enables it to take on a much wider approach in real estate investment as opposed to just focusing on purchasing properties. Private equity firms are also able to provide mid and even high yield capital to the market.
4. Private equity firms address a unique need
Private equity funds are addressing a need that other lenders in debt financing are not active such as financing borrower with little stellar credit and properties that are in transition. Private equity firms are also financing condo conversions as they make a comeback to markets like Florida. Huge banks such as Bank of America and Wells Fargo are keeping their balance sheets for the best clients. Private equity firms are taking this opportunity to offer debt financing to a wider audience while leveraging financing of properties in transition.
5. Private equity firms process financing quickly
Private equity debt is not that cheap, it attracts a higher interest rate than money borrowed from institutional lenders like banks. The advantage that private equity debt for real estate has over other financing sources, such as debt financing, is in its speedy and less bureaucratic decision making and processing procedures. Borrowers can close in on deals in less than 30 days. Private equity firms do not need developers in the real estate sector to provide personal guarantees, an element that enhances the speed with which loans are processed. They allow for co-investing that consolidated the equity and debt side of a financing deals. These elements favor real estate developers seeking to raise capital quickly to finance their projects. Thus, debt financing from private equity firms are more appealing to them.
6. Growth in realty sector appeals to private equity firms
Though there are no certainties in terms of how long private equity firms will continue to provide debt capital to the realty sector, there are high chances that loans from these firms will continue flowing into the sector in 2016 due to the growth trend in the industry. Traditionally, private equity firms do well in allocating assets and determining where their cash is deployed depending on the possible short term, medium term and long term returns. Therefore, the direction that real estate grows in the economy will determine how long private equity firms inject debt financing in the sector.
7. Private Equity firms want consistent cash flow
Investors find debt financing attractive because it generates a consistent cash flow for them. It is seen as a safer way of investing, an element that will attract more investments in the real estate sector from private equity firms.
Note: This article originally appeared on Equities with this link http://equities.com/news/7-reasons-why-private-equity-loans-will-overtake-debt-crowdfunding-for-realty-in-2016 on December 07, 2015.
David Drake is the Chairman of LDJ Capital, a multi-family office; Victoria Partners, a 300 family office network; LDJ Real Estate Group and Drake Hospitality Group; and The Soho Loft Media Group with divisions Victoria Global Communications,Times Impact Publications, and The Soho Loft Conferences. Reach him directly at David@LDJCapital.com.