Dean Dulchinos, Head of Real Estate Debt Portfolio Management and Capital Markets, recently spoke with PERE about how he expects the U.S. real estate debt market to shape up in 2019—including the opportunities it presents, the shift in both investor types and risk-reward profiles sought, and how credit cycle placement is affecting the asset class.
After 10 years of steady growth, many in the private real estate industry feel a correction is imminent, even if there are as yet no clear signs of distress. Uncertainty of this kind normally drives investors toward defensive strategies, but closed-end real estate debt fundraising actually fell in 2018 for the first time in four years, according to PERE data. However, Dean Dulchinos, Head of Real Estate Debt Portfolio Management and Capital Markets groups, tells PERE that traditional methods for tracking this part of the market do not tell the whole story. The 26-year veteran has seen investors flock to real estate debt but through different vehicles and sometimes with goals that go beyond financial returns.
PERE: What opportunities exist today for investors in the real estate debt asset class?
Dean Dulchinos: There are two primary opportunities that investors seem to be most focused on today. The first is the opportunity to enhance their existing exposure by adding real estate debt investments. Some may be long-time equity real estate investors looking to reduce volatility, while others may be fixed income investors looking to increase yield or reduce correlation within their portfolios by adding illiquid secured debt. The second opportunity is more structural in nature. Many investors seeking to invest in real estate debt are focused on open-end funds, which is a shift in the marketplace. Open-end equity funds have been around for years, but the concept of an open-end debt fund is fairly new. We have seen a number of these come into the market recently. Open-end structures can offer some advantages over closed-end structures, such as investor liquidity and capital efficiency – as these structures allow investors to maintain steady capital deployment through a single investment vehicle, rather than ramping up and down as they would with multiple closed-end funds.
PERE: What types of investors are active in real estate debt in the US and what are the attractive characteristics of debt as opposed to equity in the current market?
DD: We are seeing a lot of activity from pensions and insurance companies, both in the US and internationally, as well as sovereign wealth funds. It is an active, well-diversified investor market right now. We are a long way into a market recovery, and while fundamentals still look good, many investors are planning for potential volatility in the marketplace. For these investors, adding an allocation to real estate debt in their portfolio may be seen as a way to reduce volatility while maintaining exposure to real estate. Because debt is not in a first-loss position relative to the real estate asset, it can provide some protection against volatility if the value of the underlying real estate collateral fluctuates.
Another component of real estate debt that is attractive to investors is its ability to offer significant current income. For example, if you are invested in core equity real estate, you are looking to a combination of current income and appreciation to achieve your total return, whereas the return on a debt investment can be structured as all current income. Some real estate investors see real estate debt as a complement to equity. They may have significant equity allocations in their portfolios, but their expectations for appreciation are limited. So they may view adding an allocation to real estate debt as an opportunity to de-risk while still maintaining an attractive current return.