Debt Funds - Levering loans?
"We tend to underwrite deals to target specific IRRs, but we can also internally leverage loans to boost those returns.
For example, we might internally leverage a 70% Loan-to-Value (LTV) loan at 40% and turn a potential IRR of 10% into a 15-16% IRR.
When you’re not taking equity risk, that’s a great result."
Can anyone clarify or expand on what this guy means by "internally leveraging" loans to boost returns? How exactly does this work? Thanks
Say you raise a billion dollars for a debt fund and you make a 50 million dollar bridge loan. Instead of using $50 mil from your pool of capital, you draw down $25 mil from a warehouse line of credit (credit facility? Not sure of the correct term) that charges a lower interest rate than your bridge loan. So the $50 mil loan is funded 50% by cheaper debt and 50% by your pool of capital. Think of your capital like the equity in the deal. You’re getting interest payments from a $50 mil loan even though you only put up $25 mil of your own money. That’s how debt funds get those low to mid teen returns. If I’m still not making since, plug the above scenario into excel and see what it does to your IRR. That’s what I did when I first learned about RE debt funds
Correct
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