Our new private credit investment strategy capitalizes on the changed economic environment, offering some of the most attractive potential risk-adjusted returns of the past decade.
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Private credit (or private lending) is an asset class that consists generally of loans, fixed-income, or other structured investments that aim to deliver higher yields with lower overall risk when compared to equity investments. In other words, investors in private credit are lending money to borrowers in exchange for a fixed rate of return (often captured in the form of an interest rate or preferred return) but typically do not have any equity ownership or upside participation. Similar to other private market assets, private credit differs from publicly traded credit or fixed-income investments, such as bonds or asset-backed securities, because it is illiquid and consequently aims to deliver a higher relative return.
As a result of the Fed's extraordinary actions, today it's more expensive to borrow money for 30 days than for 30 years. This is an unnatural state of affairs that we believe is creating a once-in-a-decade liquidity crunch that we're calling The Great Deleveraging.
During this period, individuals and companies seeking to borrow money, especially in the near term, will be forced to do so at significantly more favorable terms for investors. Higher interest rates will generally mean that borrowers will borrow at much lower leverage (which means lower risk). Virtually any loan maturing in 2023 will require a paydown, and for new loans the gap between the expected and actual proceeds will likely require the use of “bridge” or “mezzanine” financing.
Meanwhile, investors who have been diligent and chose to maintain larger cash positions over the past few years will be in the enviable position of being able to demand significantly more return in exchange for providing liquidity during what we expect is likely to be a temporary period of realignment. ARN Capital is in that position.
Important Note: In our experience, these types of unique investing environments are short-lived. Accordingly, our expectation is that the current period of disruption is unlikely to last beyond 2024.
Capital Deployed into Debt Projects
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Our strategy is to focus on bridging the funding gap and providing rescue capital to borrowers in the midst of the liquidity crunch. By lending into the gap, we are able to invest at a healthy margin of safety, concentrating on high-quality assets with creditworthy borrowers—those who are experiencing circumstantial liquidity needs as a result of interest rates rising so rapidly through 2022 and 2023.
In these instances, the underlying assets themselves are typically unaffected by the financial turbulence happening in capital markets. Most frequently, the borrower is in the middle of a business plan to enhance the value of the property, such as new construction, renovations, or lease-up, and simply needs more time to reach stabilization and be ready for long-term, fixed-rate debt.
In terms of location, we will primarily target high-growth markets in the Sunbelt like Dallas-Fort Worth, Phoenix, Orlando, Tampa, Houston, Atlanta, Charleston, and Las Vegas. These are the markets we know the best: approximately 70% of all ARN Capital acquisitions from 2021-2022 were in the four fastest-growing states—Texas, Florida, North Carolina, and Georgia—and more than 90% were within the Sunbelt.
We believe that by maintaining rigorous credit underwriting with a heavy emphasis on residential rental properties, we have the opportunity to achieve some of the best relative risk-adjusted returns since the aftermath of the Great Recession in 2008.
As part of our new private credit strategy, we’ve invested roughly $20.8 million to provide financing in the form of preferred equity for the development of the Mason at Daytona Beach, a 300-unit multifamily community on 65.4 acres of centrally located land in Daytona Beach, Florida. Under the terms of the investment agreement, the borrower has agreed to pay us a 13.5% fixed annual rate that will accrue for as long as it takes to finish the project, and our investment will be paid back upon its completion. This is one of many projects in the ARN Capital Portfolio.
Read Full UpdateDuring this time, we have also worked with a majority of the top banks, sponsors, and capital brokers in the market, establishing a reputation as both a good partner and, importantly, as a partner who is not a "loan-to-own shop," seeking to prey on distress. As a result, we've become a sought-after capital source and developed a robust pipeline of deal flow tailored specifically to this type of opportunistic lending.
