The online investment platform Fundrise launched its $500 million Opportunistic Credit Fund in May, and it’s already delivered a 13% annualized yield in its first quarter.
The fund aims to capitalize on the current dislocation in the real estate credit markets by offering property loans to borrowers feeling the crunch of raised interest rates and in need of liquidity.
High-Quality Borrowers and Well-Located Assets
According to a letter to investors sent by Fundrise in July, the Opportunistic Credit Fund focuses on “high-quality borrowers backed by well-located residential assets.”
The letter explained that, based on the fund’s risk-adjusted returns, an investor who invested $500,000 for Q2 would have earned approximately $16,500 in dividends.
This robust performance comes at a time of relative uncertainty in the real estate market as the commercial sector adjusts to changes in demand brought on by an increase in remote work, and property owners scramble to adjust to the Federal Reserve’s attempts to stunt inflation by increasing interest rates.
In such a low-liquidity environment, there’s an opportunity to provide “relatively low-leverage loans for well-located residential real estate properties” that stand to increase in value in the long run.
Low liquidity in the commercial market has led the Opportunistic Credit Fund to focus on mezzanine loans, which help property owners complete projects that began when rates were lower, and now need to adjust to rates that have more than doubled in some cases. Rates on senior commercial mortgage loans saw lows of roughly 3.5% during the pandemic, and have since climbed well beyond that figure, with averages topping 7%.
The Opportunistic Credit Fund provides loans ranging from $10 million to $30 million on average to commercial landlords. The goal is to bridge the gap borrowers need to fill as property values drop with an increase in rates.
Interest Rates and the ‘Great Deleveraging’
The Fed’s sharp increase in interest rates has created a challenging environment for borrowers. In its latest letter to Opportunistic Credit Fund investors and in the fund’s initial launch statement, Fundrise argued that the higher interest rates have led to a “great deleveraging,” where borrowers seek rescue financing to pay down existing debt.
However, the company’s position is that the need for such financing isn’t necessarily due to poor asset quality but rather the transition from lower to much higher interest rates. By offering loans to these borrowers, it’s investing in what it sees as quality assets, earning returns through providing financing that the landlord cannot furnish in the current market.
“In other words, the assets themselves are solid investments, the borrowers have just become overextended, creating an opportunity for investors such as the Opportunistic Credit Fund to earn uniquely attractive returns,” argues the Fundrise team in its letter.
Fundrise’s Investment Strategy
The Opportunistic Credit Fund follows the model of the company’s other platforms. It applies to the credit market what the company has already offered in real estate and pre-initial public offering tech investments, namely an opportunity for an average individual investor to access markets usually reserved for larger institutional investors.
According to CEO Ben Miller, the goal is to offer these smaller investors a chance to profit from commercial real estate during a down cycle. This is a space usually reserved for banks, private equity funds, or family offices of ultra-wealthy individuals.
In the July letter, Fundrise wrote that the Opportunistic Credit Fund’s strategy is based on its prevailing view that interest rates will remain elevated for an extended period, possibly peaking in late 2023.
Elsewhere, Miller has made the argument that historical data suggests that peak rates are followed by a recession, but only after a lag period. If this is correct, it suggests that the current debt market dislocation will persist and that, based on the position laid out in the letter, the Opportunistic Credit Fund will continue with its current approach for some time.
“While this may be a somewhat less optimistic outlook for the broader economy,” reads the letter, “it means an extended period of time in which the current debt market dislocation exists, and for those investors who have been patient with the capital, further opportunities to earn what we feel are outsized risk-adjusted returns.”
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