Private real estate debt investors less worried about market corrections

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In times of market correction with rising interest and inflation rates, equity investors are kept on their toes. But investors in another asset class find this type of volatility much less stressful. Here’s why.

In September 2021, we saw billions of dollars wiped from the ASX, twice. 13e June 2022, growing risks of a US recession triggered a global equity selloff, wiping $82 billion off the ASX1 – the worst day in two years.

And with a market as volatile as stocks, drops of $50 billion are not unusual. With so much data available to so many people, it’s no wonder that stock markets are driven by “animal spirits” – prices can fall quickly and sharply, often without a clear logical explanation. The conundrum facing the stock investor is that he doesn’t want to miss out on gains, but is always afraid of losing because of rapid drops – “should I stay or should I go?” is never far from their mind.

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Stock prices are determined by supply and demand. If demand for a company’s stock is high, prices rise. But if demand drops, prices follow.

Demand for shares can be influenced by a range of factors, including a company’s financial performance or reputation. Macroeconomic factors such as interest rates, inflation, sluggish economic growth and unemployment can also cause prices to skyrocket. And the past two years have clearly shown the impact of disasters, like a pandemic, on the stock market.

With inflation expectations at a nearly three-year high2it’s no wonder that the wall of worry stock investors are used to climbing keeps getting higher.

But some investors are significantly less worried right now – those with money in private real estate debt.

The protective cushion of private real estate debt

Returns on listed stocks can be high, but their volatility means so are the risks.

On the other hand, investors in private real estate debt have complete visibility of their risk. Because they lend directly to borrowers and the property is the underlying collateral, they can use factors such as the loan-to-value ratio (LVR), as well as the borrower’s track record and exit strategy, to assess the risk that their investment will not perform.

And of course, private real estate investors benefit from a “buffer” that insulates their capital from market declines. The lower the LVR, the more “buffer” there is to protect your investment.

For example, if you lend $500,000 on a $1 million property-backed loan, your LVR is 50%. If the borrower defaults, there is a lot of margin between your exposure and the value of the property, so if it has to be sold, you are extremely unlikely to suffer a capital loss.

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Don’t leave your money in one basket

Diversifying your investments is always a good idea, but never more so than in a volatile market. When thinking about how to spread your investments across different asset classes, look at how they correlate to each other. Many assets move in tandem, which means that if one falls, the others will follow.

When you have a mix of uncorrelated assets, you create a diversified portfolio that is less volatile and has fewer surprises in terms of return.

Private real estate debt gives investors the opportunity to diversify their portfolio with an asset that has little correlation to other investments and offers more certain returns in an unpredictable market. So even when the markets turn volatile, the product is designed to ensure that you continue to receive consistent returns. And it’s reassuring if you rely on regular income to maintain your lifestyle.

If you’ve been procrastinating, now may be the time to revisit your asset allocation and consider looking beyond traditional asset classes. Private real estate debt can be a valuable addition to a more stable, reliable and less volatile portfolio.

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Carol M. Barragan