Real estate debt is a debt instrument that the borrower is obliged to pay back with a predetermined set of payments. The debt instrument is secured by a specified real estate property as collateral. Real estate debt typically takes the form of a mortgage or deed of trust.
The debt instrument is often a real estate debt fund, which a private equity firm creates. The collateral (real estate property) is considered securitized. In the debt structure, the securitized property is a senior real estate asset. The private equity firm finds investors interested in the fund. These investors earn a return based on fixed payments, which come from the interest earned on the debt.
Real estate debt funds focus on commercial real estate. This includes loans to developers of multi family properties, retail and shopping developments, industrial, construction, hospitality/hotel, and vacant land.
Borrowers who utilize debt funds often do so because banks are not able to meet their financing needs. Commercial real estate borrowers often have complex financial arrangements. Banks may be unwilling to create the required loan but, in some cases, simply cannot. This moves these borrowers to non-traditional financing options. Debt funds are also more flexible than banks on loan terms and can get money to developers much faster.
Debt funds got their start during The Great Financial Crisis. Bank credit contracted during this period. But new development still needed financing, which came in the form of bridge loans and new construction loans. These are not loans that banks commonly finance. In many cases, the loans are too small for a traditional bank to finance.
Real estate debt funds make money through interest payments. They will often charge at least 9%. There are also a number of fees to originate the fund and sometimes fees to close the fund (i.e., the borrower has completed all payments). Investors are paid regular interest and sometimes take a share of the fees. If the fund defaults, investors are made whole through the collateralized property.
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