Optimising investment portfolios: the case for asset-backed investments in inflationary times

The dynamic landscape of investment strategies necessitates a methodical and balanced approach for achieving optimal portfolio diversification. Astute investors continually revise and fine-tune their strategies, capitalising on opportunities that might otherwise go unnoticed. While cash flow based lending, with its dependency on an entity’s capacity to generate revenue, has become a vital component of many investment portfolios, there is growing recognition of the potential of asset- backed lending as a conservative way to invest in credit.

Asset-backed real estate debt lending offers the security of tangible collateral, an attribute that becomes invaluable in the face of the increasing volatility we are witnessing in the economic climate. In the event a borrower defaults, the physical property acts as a safety net, allowing the manager to liquidate the asset to recover their capital. This is a dimension of security absent in traditional cash flow-based lending.

However, this is not to discount the fact that cash flow based lending also incorporates various protective mechanisms such as covenants, subordination agreements, and security interests. These measures form a protective layer that differs fundamentally from the tangible asset collateral inherent in real estate debt lending.

Despite a recent slowdown in fundraising as investors retreat from making capital commitments, real estate debt has become progressively appealing as investors adopt a defensive stance in their capital allocation. PERE’s LP Perspectives 2023 revealed that 25% real estate investors surveyed aim to commit more capital to real estate debt funds. Additionally, 27% of the respondents intend to maintain their current allocations towards real estate debt in 2023.

As the investment atmosphere tilts towards downside protection, real estate debt emerges as a viable strategy with highly attractive risk-adjusted returns. Given recent banking setbacks in the US and Europe, the borrowing landscape has become more challenging, paving the way for highly responsive non-bank real estate debt providers to step in with flexible funding packages. One such opportunity lies in providing bridging loans to developers grappling with short-term liquidity issues.

Real estate debt lending holds the unique advantage of offering attractive yields with conservative Loan-to-Value (LTV) ratios. The asset-backed nature of real estate debt provides stability during turbulent times with the potential in some cases to generate near equity returns as interest rates remain stubbornly high. More so than in the past 15 years, real estate debt presents a compelling proposition for investors seeking both predictable fixed income style growth and capital preservation. Real estate debt also serves as an inherent hedge against inflation with interest rates linked to a floating base rate resulting in increased returns as rates rise. Moreover, the underlying real estate collateral often appreciates over time, further safeguarding against inflation.

These features have resulted in a surge in the number of real estate funds in market, PERE’s H1 2023 fundraising report shows $371.84 billion being targeted by closed-ended real estate funds in market. The aggregate target amount for real estate funds in Q1 2023 was $339.52 billion. This provides investors with an array of options to select funds that offer the best risk-adjusted returns. To attract capital, managers must demonstrate a robust record which is best supported by local expertise to generate differentiated opportunities through disciplined investing, underwriting insight, and proprietary dealflow. For Arrow, our 19 best-in-class local asset management and servicing platforms with more than 2,000 people on the ground gives us a practical advantage when dealing with operationally intensive and complex assets, often unavailable to other asset managers.

Recognising the underlying security of asset-backed transactions, especially in real estate debt, the Arrow Lending team will utilise the breadth of Arrow’s local asset management and servicing platforms to continue to take advantage of opportunities within the current market.

One such example is in the UK, where Maslow Capital, part of Arrow Lending Opportunities, recently reached a significant milestone having funded over 17,800 units spanning 11,230,000 sq. ft of real estate project. Their portfolio, comprising approximately £5.0 billion of developments across 258 projects, has been managed without any credit losses of capital, interest, or fees and has since 2009, yielded a gross annual IRR of 14%, secured on a weighted average loan to value of 59%. This achievement underscores the potential of securing superior risk adjusted returns if driven by careful selection, rigorous due diligence, and expert management.

In conclusion, integrating asset-backed lending strategies alongside the ubiquitous cash flow lending doesn’t necessitate a zero-sum mindset. Both strategies can coexist harmoniously, each offering unique benefits that contribute to a resilient and balanced investment portfolio. As we pilot an uncertain economic landscape, enduring success often lies in a diversified portfolio that aligns with shifting economic realities.


Private Equity Real Estate (PERE) LP Perspective 2023

Private Equity Real Estate (PERE) H1 2023 Fundraising Report