Real Estate Debt Funds Solve a Key Challenge for Developers

Overview

Real estate debt funds provide developers with the construction financing they need to quickly take advantage of opportunities as they arise. Competition for the best deals is fierce and in order to beat their competitors, developers need to move fast. Real estate debt funds play a key role by providing the liquidity developers need to come out on top. Short-term debt funds offer real estate borrowers quick access to capital, typically for under one year, that traditional lenders cannot, or will not, provide. In the current regulatory environment, most banks will not provide the kind of financing used to develop, renovate or improve a residential or commercial building.

Most real estate investors and homebuilders who borrow from real estate debt funds are experienced, have good credit, and a proven track record. And they know a good opportunity when they see it, searching for properties where the 9% to 12% interest rate they’ll pay to fund a project is small relative to the anticipated profit. Real estate debt funds generate their income through interest paid on those borrowed funds. Real estate borrowers are willing to pay higher interest rates because real estate debt funds can usually close a transaction in two weeks or less. Opportunities are often lost if the borrower cannot close fast, and traditional banks generally take 45-60 days to close.

How do real estate debt funds work?

Typically, a real estate debt fund will lend up to 70% loan-to-value (LTV) of a property’s appraised market value. For example, if a debt fund made a loan to a real estate developer whose property is valued at $1 million, the debt fund would lend up to $700,000. Thus, there is an equity cushion of $300,000 to provide a margin of safety. This feature is extremely popular with accredited investors because their investment is collateralized in a way similar to most bonds. The return, though, is much higher.

Real estate debt funds are a win-win for developers and investors. They provide developers with the funding needed to pursue construction projects. In addition, they provide investors the opportunity to earn strong returns with the protection of collateral.

For a comprehensive guide to Real Estate Debt Funds, download our free eBook.