One of the most positive things to come out of or get fine-tuned from the financial crash of 2008 was the rise of what is called real estate debt funds. Real estate debt funds connect borrowers, which, more usual than naught, are developers to short-term funding capital. This funding is used for commercial real estate projects that range from shopping centers to multi-family buildings.
It was the Dodd-Frank regulatory legislation that increased liquidity requirements through much-needed changes. The liquidity requirements called Basel III impacted asset-based lending banks and other capital lending sources who had to come up with a new way to become cash flow lenders. Real estate debt funds became one of the most profitable commercial real estate lending niches that many people don’t know a lot about.
Read on to learn more about real estate debt funding and how it’s used in commercial real estate in the guide below. Debt fund financing is one of the most lucrative private equity-backed capital available that lends money to real estate buyers or owners who have real estate assets.
Commercial Real Estate Debt Fund
Real estate debt funding relies on investors that, when they use these types of fund applications, receive payments with interest charged against the loan capital. The investors also get the security charged against the property mortgage or assets. Real estate debt funding offers collateralized loans through the senior real estate assets of borrowers for almost any type of commercial or real estate project need.
Most of the time, debt funds focus its loan strategy or investment ideas on assets that range from commercial or industrial projects to vacant land for use. The three most common types of debt funds are offered through what traditional lenders won’t consider for borrowers. That’s why borrowers with more complex or layered financial situations who can’t get a conventional credit loan can use debt financing to meet their commercial real estate purchasing needs.
Three Most Common Debt Financing Loans
The three most common types of debt financing loans offer different incentives and benefits depending on what the investor and the borrower want and need.
#1 Bridge Loans
There are times when a bridge loan may be needed by a sponsor who wants to obtain value-add to a multifamily or commercial property acquisition. Even with COVID 19 in play and many financial lenders slowing down or stopping their bridge loan services, there are financial investment companies that can find you the debt financing tool that works best for you. Bridge loans help you secure permanent financing or removes an existing financial obligation through a short term loan.
Bridge loans help you meet any current financial obligations by giving you the cash flow you need to meet your financing needs. Most bridge loans are for no more than a year and have a higher interest rate than a standard loan. They also have to be backed by some form of collateral you own or have in your range of real estate assets or inventory stockpiles.
#2 Construction Loans
Construction loans are a form of debt funding in that they are short-term loans taken out by builders or home buyers who are developing and building their own homes. They are also suitable for about one year, but borrowers sometimes refinance their construction loan by obtaining a permanent mortgage or new loan that helps them pay off their construction loan. Most of the time, borrowers have to pay interest on their construction loans if their project is ongoing and they aren’t finalized.
There are construction loans that require a borrower to pay it off completely when the project or construction is over. From the investor side, construction loans charge borrowers a minimum down payment of 20%, and some go up to about 25%. A borrower sometimes has trouble coming up with collateral for construction loans as their hard asset isn’t built yet.
To help ease an investor’s concerns, most borrowers will offer investors a very comprehensive list of construction details known as the blue book to help validate the worth and value of their project.
#3 Property Rehabilitation or Redevelopment
Property rehabilitation or redevelopment debt financing offers investors and borrowers what’s known as the sweet spot. This is the place where borrowers need too much to go to small lenders but don’t want enough to garner any interest from the large institutional lenders. That’s known to most in the financial arena industry as anything less than $100 million.
Property rehabilitation debt financing is a streamlined process where if you’re an owner or developer that lacks equity, there are financial lenders that may require a higher (Loan to Value ) LTV loan than a bank. Still, they will give you the debt funds you need for financing your redevelopment project. In practice, the loan amounts range from about $5 million to about $100 million with a (Loan to Cost) ratioLTC or LTV that’s determined by where you’re located but usually not more than 80%.
Debt Investments
One has to wonder why and how investors want to become part of the debt investment equation with borrowers. Debt funding through a direct lending funding company offers three benefits investors can’t get from almost any other type of lending process. It offers investors:
- Consistent income with a high yield every month. These high yields for investors happen even in yield-starved economies and can average about 8% on an annualized basis.
- Direct lending debt funding offers variety in a real estate investment portfolio that is diversified and allocates part of the investment dollars and income-producing product priority to all other positions in a capital stack.
- When there is capital over a large pool of loans that are optimizing loan performance predictability, investors have less loan risk and help mitigate their loan exposure.
An added benefit is the annualized net to investor return on debt financing is between 10% and 12%, which can beat the interest gained on some corporate bonds and equities.
Commercial Real Estate Investing
No matter how you proceed with your commercial real estate deal as a borrower or investor, you want to understand what you gain or lose. It’s vital you understand the terms that debt financing firms use to describe the costs and financing minutiae details for each deal. You will often hear the terms amortization, loan-to-value, underwriting, title, appraisal, surveys, and more. Each of these terms represents the lenders’ process, timeline, and any other unique transactions they provide borrowers.
Every term is usually attached to a property type of borrower category. Many borrowers are often surprised at how many debt financing lenders compete for their business. Still, borrowers that target the ones that are flexible in negotiating their lending terms often give borrowers the best deal and funding options. Lenders are in place to evaluate the risk profile of property and borrower, and the lower the risk you present, the more options you will have in debt financing for your project.
Real Estate Funds
When you’re trying to find the real estate debt financing you need for a project, you want to seek a lender that has the stellar experience and knowledge you need. That means you want to review the projects and operations they helped facilitate through their funding. You want to gauge if they’re able to move quickly within the real estate debt fund industry. There’s no doubt that by moving quickly and facilitating change when needed real estate debt funds help to serve a vital purpose in the economy.
Real estate debt financing helps provide borrowers and investors with critical tools that help the growth, success, and development of the real estate market in the U.S. 2009 saw about 28 debt funding companies launched. That number grew to 62 in 2018, and the numbers continue to rise in both the national andglobal debt financing industries.
Debt Fund Financing Future
Fund managers see private real estate debt fundraising and borrowing grow every year. In the first quarter of 2020, there were about 436 funds that had a net worth of over $192 billion. That’s why lenders are raising more funds than ever thought possible with lower risk profiles of properties and borrowers than they ever imagined.
The lower the risk, the better the terms. That’s why debt fund financing works so well in commercial real estate. There’s even some preliminary talk of debt fund financing being consolidated as an industry in the near future. The lending environment has been healthy in volume and opportunities.
Debt fund loans are indeed for a specific commercial real estate deal, project, or borrower. But some companies are branching out and may only be a matter of time before some of these debt financing companies start competing with banks for the conventional or traditional commercial loan. Debt funds are always an exciting and viable option for borrowers that need commercial financing. Reach out to CommLoan for the real estate debt financing you need and see the infinite value you’ve added to your future financial success.
FAQs
How does a debt fund work? ›
Debt funds invest in either listed or unlisted debt instruments, such as Corporate and Government Bonds at a certain price and later sell them at a margin. The difference between the cost and sale price accounts for the appreciation or depreciation in the fund's net asset value (NAV).
Are debt funds regulated? ›This puts bank financing at a competitive disadvantage compared to debt funds, which are not regulated in this respect. The latter are accountable only to their investors, meaning that they can price a much broader range of risks.
What are debt funds? ›A debt fund is a Mutual Fund scheme that invests in fixed income instruments, such as Corporate and Government Bonds, corporate debt securities, and money market instruments etc. that offer capital appreciation. Debt funds are also referred to as Fixed Income Funds or Bond Funds.
How does a private debt fund make money? ›Private debt generates returns from interest in loans, while private equity funds seek to generate returns by increasing the value of portfolio companies.
What is a debt fund in real estate? ›A real estate debt fund consists of private equity-backed capital that lends money to prospective real estate buyers or current owners of real estate assets.
How safe is debt fund? ›Debt funds put money in fixed income securities. It is safer as compared to equity funds which invest in stocks and are subject to the volatility of the stock markets. You may diversify your portfolio with debt funds. The safety of debt funds depends on the type of debt funds and the interest rate fluctuations.
Which debt funds are best? ›| Scheme Name | Expense Ratio | 1Y Return |
|---|---|---|
| UTI Banking & PSU Debt Fund | 0.23% | 8.87% p.a. |
| UTI Bond Fund | 1.3% | 8.3% p.a. |
| Nippon India Ultra Short Duration Fund | 0.38% | 4.75% p.a. |
| ICICI Prudential Ultra Short Term Fund | 0.39% | 4.36% p.a. |
Number 1: Safety-First: Debt Categories where safety of principal is the focus. Two fund categories, Overnight Funds and Liquid Funds fall in this category. These are the safest funds in the debt category with negligible interest or credit risk.
How many debt funds should I have? ›Ideally, 6 to 8 funds are good enough to build your MF portfolio. As the size of the portfolio increases, you may invest in a maximum of 10 funds to reduce the risk of being overdependent on any particular fund or fund house. However, the funds you are investing in are across equity, debt and hybrid categories.
How do debt funds raise capital? ›Debt financing occurs when a company raises money by selling debt instruments to investors. Debt financing is the opposite of equity financing, which entails issuing stock to raise money. Debt financing occurs when a firm sells fixed income products, such as bonds, bills, or notes.
How do I prepare for a private debt interview? ›
- Strong financial modelling skills a must.
- Corporate or project finance credit analysis.
- Basic knowledge of fixed income is nice to have. Ie. understanding of the bond market, how interest rate and duration impact bond valuation, yield curve, etc.
The money is provided to the business by lenders and shareholders. In the process of raising funds for capital, businesses create debt in the form of bonds and equity, usually in the form of stocks.
Are debt funds private equity? ›Navita: Unlike private equity funds, investors don't use private debt funds to own shares in a company. As with most loans, borrowers pay lenders back with interest over time, according to specified terms.
Is private debt regulated? ›Private credit firms are regulated as asset managers and the funds they manage are subject to ongoing regulatory supervision and oversight.
What is private debt? ›Private debt refers to loans that are typically made by non-bank investors. Companies typically access private debt to finance growth, expand their working capital, or fund real estate development. Institutional investors have increasingly turned to private debt as a source of diversified returns.
What is commercial real estate debt investment? ›Commercial real estate debt is money that is provided to purchase, refinance, or construct commercial real estate assets. Each deal is unique and tailored to the needs of the borrower. For investors interested in commercial real estate debt investing, there are public and private options.
Why is debt good in real estate? ›Although “debt” is generally thought of as a liability, the debt used to finance commercial real estate deals can be extremely positive. Simply put, it's a way of putting someone else's money to work for you as you grow your investment portfolio.
Why is debt cheaper than equity in real estate? ›Debt is cheaper than Equity because interest paid on Debt is tax-deductible, and lenders' expected returns are lower than those of equity investors (shareholders). The risk and potential returns of Debt are both lower.
Why debt funds are not performing? ›However, a rise in interest rates negatively impacts the returns from debt funds as the face value of debt instruments falls. Rate hikes amid rising inflation make investors worry about debt funds' returns. Additionally, equity markets are volatile due to rising inflation and interest rate.
Are debt funds tax free? ›Debt Funds are liable to be charged two types of taxes depending upon the period for which they are held. These two types are the Short-term Capital Gain tax and the Long-term Capital Gain tax.
Which is the safest debt fund? ›
The safest debt funds w.r.t credit risk
If you want to invest in debt funds that carry barely any credit risk, gilt funds are perhaps your best bet. These debt funds invest mainly in government securities (G-Secs) like government bonds.
Choose a debt fund whose duration matches your financial needs. Liquid and overnight funds carry the lowest credit risk, ultra short term to short term funds are moderately riskier, and the long duration funds carry the highest risk amongst the debt funds.
Do debt funds give monthly income? ›Monthly Income Plans, known as MIPs, are debt-oriented hybrid mutual funds that give a fixed return every month to the investor. The ratio of equity investments is considerably low, but is just enough to give you an added advantage to the stability of the debt part of the fund.
When should you buy debt funds? ›Short-term goals: Ideally, you should invest in debt mutual funds when you have a short-term investment goal and avoid too much volatility. To meet short-term capital requirements, you can consider liquid, ultra-short, low duration, and money market funds. These funds come in the span of six months to one year.
Which debt fund is good for 3 years? ›...
Best Corporate Bond Funds.
| Fund Name | ETMONEY Rank | 3-Year Return |
|---|---|---|
| Kotak Corporate Bond Fund | 1 | 8.54% |
| ICICI Prudential Corporate Bond Fund | 2 | 8.85% |
| Nippon India Corporate Fund | 3 | 8.20% |
| Aditya Birla Sun Life Corporate Bond Fund | 4 | 9.39% |
Debt Funds are categorized as follows: Overnight Funds – invest in 1-day maturity papers (securities) Liquid Funds – invest in money market instruments maturing within 90 days Floating Rate Funds - invest in floating rate debt securities. Ultra-Short Duration Funds – invest in debt securities maturing in 3-6 months.
Why should I invest in debt funds? ›The fundamental reason for investing in debt funds is to earn a steady interest income and capital appreciation. The issuers of debt instruments pre-decide the interest rate you will receive as well as the maturity period. Hence, they are also known as 'fixed-income' securities.
How many funds make an ideal portfolio? ›So, what's the magic number? There isn't a strict rule, but between five and 10 funds is usually a good idea. That lets you allocate money to different types of funds and markets without doubling up too much. It's also a manageable number to monitor and won't cost you too much in trading fees.
Are debt funds good for long term? ›Investors should invest in long term debt funds if they have an investment time frame of more than 3 years. Also, this fund is only suitable for investors who are willing to take some level of risk in the investment.
Which of the following is a risk associated with debt fund? ›Interest rate risk
This risk is due to the negative correlation between the interest rate and the bond price in the market.
What are the disadvantages of debt financing? ›
- Paying Back the Debt. Making payments to a bank or other lender can be stress-free if you have ample revenue flowing into your business. ...
- High Interest Rates. ...
- The Effect on Your Credit Rating. ...
- Cash Flow Difficulties.
The capital stack refers to the layers of capital that go into purchasing and operating a commercial real estate investment. It outlines who will receive income and profits generated by the property and in what order.
Which is better debt financing or equity financing? ›Is Debt Financing or Equity Financing Riskier? It depends. Debt financing can be riskier if you are not profitable as there will be loan pressure from your lenders. However, equity financing can be risky if your investors expect you to turn a healthy profit, which they often do.
What questions do they ask in a private equity interview? ›- How many funds and/or product lines does the firm operate? ...
- Which kind of assets does the company invest in? ...
- What is the fund's investment strategy? ...
- What is the size of the fund? ...
- Which stage of the company's lifecycle does the fund invest in? ...
- Where is the fund present?
Private equity interviews can be challenging, but for most candidates, winning interviews is much tougher than succeeding in those interviews. You do not need to be a math genius or a gifted speaker; you just need to understand the recruiting process and basic arithmetic.
Why is LBO floor valuation? ›To recap, a LBO model is often called a “floor valuation” as it can be used to determine the maximum purchase price the buyer can pay while still reaching the fund specific returns thresholds.
What are the 4 sources of capital? ›She suggests that there are in fact 4 sources of capital: equity, debt, grants and sales/revenue. There are 3 types of equity for funding operations: Public Equity, External Private Equity and Internal Equity. Public equity or securities include IPOs and crowdfunding efforts.
What are the 3 types of capital? ›When budgeting, businesses of all kinds typically focus on three types of capital: working capital, equity capital, and debt capital.
Is it good to invest in debt funds? ›If you are looking to earn a regular income from your investments, then Monthly Income Plans may be a good option. Investing in debt funds is ideal for risk-averse investors as they invest in securities that offer interest at a predefined rate and return the principal invested in full upon maturity.
How can I make money with debt? ›- Purchase real estate with a mortgage. Real estate can be a great wealth-building strategy for high net worth individuals. ...
- Use commercial loans for your business. ...
- Leverage your human capital: get an education with student loans.
Is debt fund better than FD? ›
An FD is more secure than a debt mutual fund, and market fluctuations do not impact the interest rate. A debt mutual fund is good for investors who are okay with the risk factor.
What are the disadvantages of debt financing? ›- Paying Back the Debt. Making payments to a bank or other lender can be stress-free if you have ample revenue flowing into your business. ...
- High Interest Rates. ...
- The Effect on Your Credit Rating. ...
- Cash Flow Difficulties.
| Fund Name | 1Y CAGR 3Y CAGR 5Y CAGR Till Date CAGR | Till Date CAGR |
|---|---|---|
| ICICI Prudential Liquid Fund (G) | 4% | 7.1% |
| HDFC Floating Rate Debt Wholesale Plan (G) | 6% | 7.8% |
| Nippon India Arbitrage Fund (G) | 4% | 6.8% |
| Aditya Birla Sun Life Savings Fund (G) | 5.2% | 7.4% |
However, a rise in interest rates negatively impacts the returns from debt funds as the face value of debt instruments falls. Rate hikes amid rising inflation make investors worry about debt funds' returns. Additionally, equity markets are volatile due to rising inflation and interest rate.
How many debt funds should I have? ›Ideally, 6 to 8 funds are good enough to build your MF portfolio. As the size of the portfolio increases, you may invest in a maximum of 10 funds to reduce the risk of being overdependent on any particular fund or fund house. However, the funds you are investing in are across equity, debt and hybrid categories.
What are examples of good debt? ›- Student loan debt.
- Home mortgage debt.
- Small business debt.
- Auto loan debt.
- Credit card debt.
- Payday loans.
- Borrowing to invest.
- Predatory/High interest loans.
- Get any available employer match.
- Pay off high-interest rate (8%+) debt.
- Max out available retirement accounts.
- Invest in assets with high expected returns.
- Pay off moderate interest rate (4-7%) debt.
- Invest in assets with moderate expected returns.
So while you cannot buy your own debt, you can often get your debt discounted with lenders, collection agencies and debt buyers. How much of a discount is always subject to different variables. Some of the coming changes to collections and debt buying markets will certainly have an effect on those discounts.
Are debt funds tax free? ›Debt Funds are liable to be charged two types of taxes depending upon the period for which they are held. These two types are the Short-term Capital Gain tax and the Long-term Capital Gain tax.
Do debt funds give monthly income? ›Monthly Income Plans, known as MIPs, are debt-oriented hybrid mutual funds that give a fixed return every month to the investor. The ratio of equity investments is considerably low, but is just enough to give you an added advantage to the stability of the debt part of the fund.
Which debt fund is best for long term? ›
- ICICI Prudential Corporate Bond Fund.
- Nippon India Prime Debt Fund.
- SBI Magnum Gilt Fund.
- Aditya Birla Sun Life Corporate Bond Fund.
- ICICI Prudential Gilt Fund.
- Sundaram Corporate Bond Fund.
- Kotak Corporate Bond Fund Standard.
- HDFC Corporate Bond Fund.
- Bank loan. A common form of debt financing is a bank loan. ...
- Bond issues. Another form of debt financing is bond issues. ...
- Family and credit card loans. Other means of debt financing include taking loans from family and friends and borrowing through a credit card.
Reasons why companies might elect to use debt rather than equity financing include: A loan does not provide an ownership stake and, so, does not cause dilution to the owners' equity position in the business. Debt can be a less expensive source of growth capital if the Company is growing at a high rate.
Which is more risky debt or equity? ›The main distinguishing factor between equity vs debt funds is risk e.g. equity has a higher risk profile compared to debt. Investors should understand that risk and return are directly related, in other words, you have to take more risk to get higher returns.