Executive Summary
$200.4 billion was raised in 2022 across 159 private debt funds, a three-fold increase from 2012.
Global private debt funds had an AUM of $1.2 trillion, representing 9.7% of the total private capital AUM of $12.4 trillion in the same year.
The 2023 and 2024 vintage year private debt funds could be spectacular from a return perspective.
A significant portion of the future growth of private debt will come from outside of the developed markets.
Brazil, Mexico, Chile, Colombia and Argentina are expected to be the regional markets receiving the most private debt capital investments.
Private Debt as an Asset Class
Private debt can be defined as a form of non-bank & non-publicly traded lending to businesses and projects with set repayment terms and interest charged. Investors are taking a closer look at debt funds in 2023 because of their ability to generate steady returns in a rising interest-rate environment. According to Pitchbook, $200.4 billion was raised in 2022 across 159 private debt funds, a three-fold increase from 2012.
Figure 1: Private Debt Fundraising Global Activity in 2022
In 2022, global private debt funds had an AUM of $1.2 trillion, representing 9.7% of the total private capital AUM of $12.4 trillion in the same year. The allocation to private debt funds is expected to increase in relative terms given where interest rates are today (i.e., 6 month t-bills yielding 5%+).
Figure 2: Private Debt AUM as a % of Total Private Capital AUM
Private debt funds possess inherent advantages to both investors and investees, relative to their private equity counterparts. Investors appreciate that the investment is collateralized, and that credit underwriting is generally more conservative. Fees tend to be lower, and capital returned sooner and quicker than with most equity investments. The primary benefit to investees of private debt is the ability to avoid, or significantly reduce, dilution.
The story for private debt isn’t all sunshine and roses. Underwriting is often more robust for debt transactions with the due diligence focused on determining the financial stability of the investment, rather than the more subjective future growth predictions inherent to equity underwriting. Some companies will be choked by debt and repayment obligations that produce unacceptable debt ratios. Investors and investees are less familiar with certain structured debt terms and may require extensive education pre- and post-investment. Lastly, less developed markets sometimes have onerous legal restrictions on credit providers.
Private Real Estate Debt Funds
Real estate private debt funds are an important part of the private debt market cap and have experienced impressive AUM growth rates since 2010. The 2023 and 2024 vintage year funds could be spectacular from a return perspective, which would lead to a fundraising bonanza for the asset class over the next five to ten years. These vintages will benefit from higher interest rates, lower real estate entry-point valuations, tighter LTVs, and the potential to gain even more as interest rates come down in the future.
Figure 3: Private Real Estate Debt Funds AUM Growth
Banks are increasing their internal lending standards because they are concerned about performance of existing books of debt, including real estate debt. The mismatch between their current cost of capital, and the interest rate they are receiving from their book, isn’t adding up in some cases (e.g., Silicon Valley Bank failure). Regulatory scrutiny is increasing in the form of capital adequacy ratios and stress testing. Until the uncertainty is lifted, new real estate projects in the developed world seeking debt financing can expect to be offered LTVs closer to 50% - 55%, rather than the 60% - 65% which has been the norm. This debt gap will be filled in part by private real estate debt funds.
Application to Latin America
A significant portion of the future growth of private debt will come from outside of the developed markets. The total value of private debt deals announced in Asia, Latin America, Africa, Central and Eastern Europe, and the Middle East grew 89% between 2021 and 2022. Banks retreated from emerging market lending during the global lockdowns and they don’t seem eager to return.
Historically, Latin America inbound private investments have been through private equity, infrastructure and natural resources. In recent years, private debt and venture capital have taken AUM market share, with private equity suffering the most. Private equity returns have been lackluster in the region due in part to difficulty in achieving exits at scale which is required for the investors to realize the promised returns. Other factors negatively effecting equity returns have been corruption, currency volatility, economic instability, left-wing politics, drugs and cartels, a relatively small pool of fund managers, and the concentration (i.e., 70%) of large business which are family-owned (i.e., dilution concerns by the family).
Figure 4: LATAM AUM by Private Fund Type
The dominate countries in Latin America in terms of private capital AUM are Brazil and Mexico, with Mexico recently gaining significantly on Brazil. The second-tier countries each have similar private capital AUMs and include Chile, Colombia and Argentina. The countries named in the chart below are expected to be the primary beneficiaries of the new private debt funds being raised for the region. In total, the region received nearly $80 billion of private capital investment in 2021.
Figure 5: LATAM Private Fund AUM by Country
The next wave of international private capital to real estate in Latin American will be buoyed by the proliferation of REITs (particularly in Brazil, Mexico and Colombia), more robust private equity ecosystems, and a growing number of active pension fund investors. There are now more buyers and funders of stabilized real estate projects in Latin America, locally, than was the case with previous international investment waves.
The issue in Latin America continues to be early-stage capital for new real estate projects. The dearth of risk capital forces many developers to pre-sale portions of the project, receive a two to four year construction loan from a bank based on those agreements, with the loan being repaid after the project is completed and units sold to the initial buyers. There are many problems associated with this method of funding new projects, and its no coincidence that the techniques are only relied upon in markets without robust capital markets.
A newly formed private real estate debt fund is unlikely to have issues generating bankable regional deal flow. The new funds may have success approaching banks to purchase some of their performing and non-performing real estate debt. Banks are under pressure to pass stress tests and meet liquidity requirements and selling prime real estate debt could be an attractive solution. Projects that are delayed, or with a high percentage of presale defaults, might benefit from fresh private debt to remove the bank from the capital stack. Cost overruns are common in the current environment due to construction cost inflation. These projects could benefit from a bridge loan from a private debt fund.
Contributor to this paper: Nathan Whigham, Founder and President of EN Capital.
Comentarios