Key Takeaways:
- Private credit and real estate-backed private funds are considered separate asset classes, influenced by different factors and backed by a variety of collateral types.
- Real estate-backed funds are secured by physical property, giving them a collateral floor that is often more comprehensive than a typical private credit portfolio.
Investors are seeing a lot of headlines these days about private credit. “Private credit faces mounting pressure.” “Cracks forming in direct lending.” If you’re invested in a real estate-backed private fund, you may be wondering how this compares to other private investments.
To answer that question with any confidence, it helps to understand what private credit actually is, how it’s structured, who it lends to, and why that matters.
First, What Is Private Credit?
Private credit is, at its simplest, lending that happens outside of the traditional banking system. Most of the market is direct lending in the form of senior secured loans to middle-market companies, but the asset class is broader than that. It also includes mezzanine financing, distressed debt, venture lending, and various forms of asset-backed finance. The common thread is that these are privately negotiated transactions between borrowers and mostly non-bank lenders, each with their own risk profile and return characteristics.
In the years following the global financial crisis, banks pulled back from lending to middle-market companies as regulators imposed stricter capital requirements and underwriting standards. Private credit stepped in to fill that gap, offering borrowers something banks couldn’t easily match: speed, flexibility, and highly customized deal structures. That combination proved compelling on both sides of the transaction, helping fuel private credit’s growth into a nearly $2 trillion asset class. Part of private credit’s success has been its consistent track record until now.
The investor base in private credit has historically been institutional, but have more recently been available for retail investors. Pension funds, insurance companies, sovereign wealth funds, and ultra-high net worth families have been the primary allocators, drawn by the yield premium borrowers pay over traditional bank rates and a willingness to accept the illiquidity and lockup periods that come with the asset class. Private credit also offered portfolio diversification benefits, with returns that have historically shown less than perfect correlation to public equities and fixed income.
Why has private credit come into focus lately?
Private credit has come under increasing scrutiny as several structural risks within the asset class have surfaced. The illiquid nature of these investments makes price discovery inherently difficult. These types of loans rarely trade on secondary markets, and fund managers have some discretion in how they mark positions. This valuation opacity was put into sharp relief by specific cases cited in the media recently, where some valuations have proven to be too optimistic. Beyond pricing, the underlying collateral across private credit is far from uniform. Deal terms are often customized, which at times can make it difficult to discern the true risk profile of the loans. And a share of lending is concentrated in sectors with low tangible assets and collateralization, making default recoveries more difficult. Finally, technology disruption through AI has been more acute in the private credit space as opposed to residential real estate.
How does a private credit fund compare to a private real estate fund?
Private real estate is not without risk, but the variables impacting the asset class often are more quantifiable. A real estate fund is typically secured by physical land and/or structures. A residential real estate fund, for example, has investments in build-to-rent communities, multifamily properties, and non-performing loans; all of which possess hard assets acting as collateral. That collateral provides a tangible floor on recovery that might not exist or is not as comprehensive in private credit. The forces that drive real estate performance, like housing supply and demand, occupancy trends, interest rate cycles, and demographics, are well known. However, they can still manifest themselves in unexpected volatility consistent with most financial assets. Notwithstanding that, one of the appeals of real estate has been the favorable backdrop, which has been a dearth of supply on a national basis, mostly due to under-construction in single-family housing. Of course, underwriting and operations also matter a great deal in securing the investment over the long term.
We’re Here to Talk Through It
Access to alternative investments like real estate is important for many individual investors. Understanding the investment you’re making, including the risks and the degree of collateralization, are essential factors of an investor’s decision making.
The PPR team has spent years building expertise in all aspects of residential real estate, such as the macroeconomic environment, asset-level underwriting, and competitive trends, including navigating the 2008 financial crisis, pandemic volatility, and rising interest rates. That experience shapes how we approach every deal.
If you’d like to talk through PPR’s investment thesis, what’s in the current portfolio, or simply understand more about how we assess risk and return, we’d welcome the conversation.
