Quick Thoughts: An Expanding Universe in a Volatile World—A Focus on Private Real Estate and Private Credit

How is the current challenging economic environment impacting private markets? The Franklin Templeton Institute hosted a webinar with Tim Wang, Head of Investment Research at Clarion Partners, which invests in private real estate, and Rich Byrne, Senior Managing Director at Benefit Street Partners (BSP), a private credit investor. Here are my key takeaways:     

• Institutions on average have about 11% of their portfolios in private real estate.¹ While the current levels of inflation and the possibility of recession are challenging for real estate investors, Clarion thinks that industrial warehouses, life science facilities, and multi-family rental properties can provide strong returns as well as hedge against inflation. Most retail and office space properties will face difficulties in this environment. 
• Publicly traded real estate investment trusts (REITs) are approximately 15% of the total investable real estate universe² and they are highly correlated to equities. Private real estate provides a diversification benefit relative to stocks and bonds.
• The modern private credit market emerged after the Global Financial Crisis (GFC) to fill the void left by banks that significantly reduced their lending to small- and medium-sized businesses. The sector is benchmarked to high-yield debt based on its perceived risk profile, and generally prices its debt at a 150 basis-point premium to syndicated loans.
• Higher interest rates and inflation make floating-rate private credit more appealing. In this challenging environment, private credit providers, like BSP, can require stricter requirements on loan documentation and higher equity cushions (lower loan-to-value). These give investors higher yields that float as interest rates change and a lower risk profile.   
• As interest rates rise it is a better time to be a lender. Current pricing in both private credit and private real estate debt is priced to compensate investors for the added risk of increased defaults.    
   

Private markets can offer direct exposure to sectors of the economy that differ from public markets.  This can help reduce the volatility in a portfolio that contains publicly traded securities, which are often subject to extreme swings in sentiment regardless of the underlying fundamentals.