Private real estate credit offers diversification benefits to a variety of asset classes:
To Fixed Income: Relative to public high-yield and investment grade bonds, investors in private real estate credit can expect a lower observed volatility profile, supported by an appraisal-based valuation process, with lower sensitivity to broader market movements. Private real estate credit may also help mitigate a fixed income portfolio’s interest rate sensitivity, as the majority of loans are floating-rate, leading yields to increase if interest rates rise, and structured with interest rate floors creating a buffer if interest rates fall. This contrasts with high yield investments, a core public credit holding, which are fixed-rate. Although interest rates are off peak levels, we believe that levels are unlikely to revert to pre-COVID levels, offering an attractive base rate that should support returns going forward. Being in a control position in the capital structure as opposed to investing via a club of lenders or as a participant enables active risk management throughout the hold period.
To Private Corporate Credit: Private real estate credit offers diversifying underlying sources of risk from the corporate market and, therefore, from the broader macro and corporate M&A cycle. Real estate and private credit have diverged cyclically since COVID. Assuming real estate has bottomed, as previously discussed, investors in today’s market can deploy capital at a reset basis – an opportunity that is not available to private credit investors. Real estate is the beneficiary of trends that house the U.S. economy, such as digitization (data centers), evolving supply chains (industrial) and demographics (multifamily, student housing), which transcend macroeconomic cycles. In addition real estate loans are secured by tangible assets with the ability to lay claim on the property in the event of a default or foreclosure. To the extent a lender needs to foreclose on a property, there are various ways to preserve principal in the investment and/or explore liquidity options for the underlying asset. Private real estate credit is supported by cash-paying loans—offering investors consistent yield and reliable cash flow. While many private corporate credit strategies are also cash pay, there has been an increased prevalence of payment-in-kind interest which has not presented in the real estate lending markets.
To Real Estate Equity: Loans secured by real estate assets may offer similar inflation protections as real estate equity, insofar as underlying collateral values can increase with rising prices. Owning property generates total returns through appreciation and income over a medium to long-term time horizon, whereas real estate credit provides current income from a defensive position with an equity cushion, insulating some risk if property values fall. Senior mortgages are the first to be paid and last to incur losses in the capital structure in the event of a default.
Private real estate credit ownership through REIT structures can provide potential attractive after-tax distributions for U.S. taxable individual investors. Non-U.S. investors and U.S. tax-exempt investors are subject to additional tax considerations not discussed herein.
REIT distributions are taxed at different rates depending on whether they are characterized as ordinary dividend, capital gains dividend or return of capital (“ROC”) distribution.
U.S. taxable individual investors benefit from a 20% tax rate reduction on ordinary REIT dividend. The legislation commonly known as the “One Big Beautiful Bill Act” recently made permanent both the 20% deduction and the maximum individual tax rate of 37%.
The 20% tax rate deduction reduces the federal income tax rate for ordinary REIT dividend payments from 37% to 29.6% for U.S. taxable individual investors in the highest tax bracket resulting in payments that may produce attractive after-tax distributions compared to a hypothetical investment generating distributions classified as ordinary income, not subject to the 20% deduction and not classified as a ROC. 1, 2, 3, 4, 6
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