RE Private Credit outlook
Reading that the incoming covid debt wall coming due will be hot for the private credit market. Thoughts? Are there going to be more hiring?
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We've been just months away from hitting a debt wall for years now. I think the willingness to extend-and-pretend isn't going away as long as the asset isn't physically distressed. In our loan book, we've extended some that were very senior and performing, but we've also already taken back one where we could read the writing on the wall.
Banks have pretty much dumped the loans they really don't like by now and will probably be willing to play ball on what's left. For debt fund's, depending on their structure, they're willing to play ball rather than recognize issues as well. Last are the CLO issuers, which will trade bad loans out/buy at par out of their CLOs for as long as they can to maintain the illusion.
Now speaking more broadly, I still see opportunity in the RE credit space - more if Trump doesn't completely gut Basel III regs, but even without, banks would rather let a fund do the originations and take a senior piece. Additionally, if the GSEs get IPO'd, I think that'll raise spreads and make more room for competition. In summary, I'd say yes - RE credit is going to see hiring and continued growth, but for structural reasons outside the debt wall.
I think the private credit space is just like many of the other flavor of the month finance sector we've seen for the last few years/decades - here to stay but in the moment way overblown. Always remember that financiers are among the most risk-averse people on the planet. Everyone is doing private credit now, because that is what bankers and lenders do, they rush into the next big thing because it gives them the opportunity to make a lot of money and shrug off any downsides with the "everyone is doing it" excuse.
It's hard for me to see how there is enough demand to meet the supply out there, at least as I understand it anecdotally. Private credit isn't going to replace traditional mortgage lending, because even if there is a wall of maturities coming (the same wall we hit 18 months ago according to the financial press, I'll remind you), sponsors simply aren't going to be interested in putting up millions of additional dollars of equity/collateral/guarantees to hold on a building they're pretty positive is going to be in the hands of their private credit lenders within a few years. So yeah, private credit in the real estate space plays a useful niche role, especially in riskier and higher rate scenarios like construction lending... but an industry in which the principals take risk (like real estate) versus one like private equity where losses flow to the investors and gains to the bankers, there just isn't as much of a widespread use case for private credit.
Too much capital raised chasing too few deals. Yes, it makes sense on paper with the 'debt wall' approaching, but banks are extending/pretending and borrowers aren't desperate enough to take on the less-favorable terms of the private credit folks. I also don't think LP's like to hear that a deal requires debt fund money to work.
Yes there are cowboy GP's who go with it, but they are the outliers and far outnumbered by the folks who drive with 10-and-2 on the wheel. In my experience, among borrowers who do go debt fund, it's for a 1-2 year bridge to get permanent financing. So there's a role for it, but there's an artificially small window.
I think this misrepresents GPs a little. There are plenty of GPs who are both greedy and impatient, and aren't too fussed about things like responsibility to their investors or proper bookkeeping or appropriate risk management. Those guys will take out crazy expensive debt because they're not really developers, they're gamblers, it's just not possible to convince people to give you millions of dollars to take to Vegas, but it is possible to do that with a real estate deal.
There is a reason that during every boom cycle we see puff pieces on the latest wunderkind who is building a real estate empire from scratch and how they've got a dozen transformative projects and are living in a 8 figure mansion and flying to the Caribbean on private jets and yadda yadda yadda, and then magically and almost without fail you read about them five years later and not only are all the projects nearing a UCC foreclosure, but it's coming to light that the principals were misappropriating escrows and using project funds for extravagant personal expenses and that the whole thing was a house of cards from the word "go".
Real estate is a business where success takes decades, not months, and in which there are a lot of extremely cheap, extremely well-tested debt products that extend out that long. With that context, it should be obvious that anyone who has regular recourse to private credit or mezz debt instead of more traditional lending sources is essentially running a shell game which will implode. I genuinely think that a developer who turns to alternate lending sources on a regular basis is signaling something to the market as a whole; either that their deals are all underwater, or that they themselves are criminals looking to extract that last buck before it all becomes obvious.
https://www.wsj.com/real-estate/michael-shvo-real-estate-developer-9cdf45eb?mod=hp_lead_pos6
lol
Haha I swear I hadn't seen that story before I posted!
But whoa, what a surprise! The guy who built a real estate empire on a mountain of debt and very little actual analysis or ability is being caught out as building another business on a mountain of debt and very little analysis or ability?
It just goes to show the degree to which investors and lenders are fundamentally not very good at their jobs. The same fucking failures get second and third and fourth chances despite repeatedly proving their incompetence and inability to execute, while tons of people who might actually have some shred of intelligence or talent or innovation sit on the sidelines.
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