During the last decade pension funds, insurance companies and sovereign wealth funds increasingly have been viewing real estate private debt as an attractive asset class to add diversification to their traditional fixed income strategies in a historically low yield environment.
With $638bn private debt assets under management in 2017, the asset class more than tripled from $205bn since the end of 2007 with direct lending being one of the most attractive private debt strategies among institutional investors powered by a direct relationship to borrowers, asset control and deal monitoring.
With the main categories of the private debt market, i.e. direct lending, distressed debt, venture debt, mezzanine, and the related hybrid areas like the German Schuldschein and US Private Placements, the direct lending space has not been through a credit downcycle yet.
As of 2019 with the ECB expected to withdraw stimulating measures following the FED’s policy, the times of cheap capital are likely to come to an end and will affect credit markets with yields coming back to traditional fixed income products. As bank rates at the end of the credit cycle naturally will begin to surge, there is the increasing possibility of debt book defaults which will not exclude private debt portfolios.
Since the lending market is driven by heavy competition among banks and alternative lenders, it will be interesting to see how the competitive advantage of direct lenders in terms of overall flexibility in structuring will play out and evolve.
Whereas banks cite their large deal books, balance sheets, team and corporate infrastructure size as their main competitive advantage over private debt providers, the pursuit of opportunistic strategies including niche areas, the search for high quality borrowers, and tight risk management will be even more decisive for private lenders to prevail in a fierce competitive landscape in which regulation will not go away and continue to impact the geographical competition for investor inflows.