Debt Fund Returns - What are their targets and how are they achieved?
Curious if anyone has insight into debt fund return targets. Bridge loans in today's environment can generally get you a ~12% gross IRR, but over the past few years and looking forward, these returns are in the low double digits. If a fund is targeting a net 10-11% after fees, expenses, promote, etc., how do they hit this?
Leverage - selling an a-note, note on note, or warehouse line
Yes, but that’s how they’re getting to the 12%. Otherwise, whole loan spreads would get you in the mid to high single digits. To hit a net 10% return, you’d figure they’d need to hit somewhere around 13-14% consistently, which doesn’t seem to be market.
15%+ easily nowadays
Either through interest + sofr + origination fees + non-utilisation fees + exit fees + make whole fees
(In other words, if you reverse the cash flows of your leverage section in your model, you have a crude gross IRR for the lender)
Or
A whole loan whereby you write a facility of say 80% at say an all in interest cost of 10% all-in, then carve off the A-note (let's says 60%) LTV to a core investor with a low cost of capital at say 6% then take your upside on the remaining 20% which generates a return higher than 10%.
Regarding your last point - do you know of any resources that walk through the math to get to that >10% return?
Try to figure it out yourself, I'll let you know how close you are and give you pointers (hot/cold) along the way
Very, very high level description but I feel illustrates the trade well: Originate $10,000,000 bridge loan. Assume 8% interest, that's $800,000 annual interest income on the whole loan. Carve out 60% into an A-note, paying 6% interest. That would be a $6,000,000 A-note that receives $360,000 annually. The B-note receives the remaining interest after the A-note is paid. That would be $800,000 - $360,000 = $440,000. Remember the B-note would have a loan balance of $4,000,000. The return of $440,000 on $4,000,000 would be 11%. This isn't even factoring in origination/exit/extension fees/etc. The higher you juice the B-note the higher return the manager can get, AKA increasing the carve out % for the A-note and/or decreasing the interest payable for the A-note.
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