Insights

As the Feds continue to inch interest rates to quell inflation, it’s no surprise that many economists predict another year of continued market volatility on the horizon in 2023. In a recent poll, Reuters found that economists also increased the probability of a recession within two years to 70% from 63% previously.

When markets are unstable, private credit strategies offer an attractive way to diversify your portfolio independent from the ups and downs of the stock and bond markets. In fact, this portfolio alternative can offer greater protection through all market cycles.

“We believe that private credit is essential to buffer portfolios not only when markets are volatile but through all market terrain,” says Don Pelgrim, CEO and Fund Manager with Wilshire Finance Partners. “It gives investors access to non-traditional investments to help balance risk exposure and expand fixed income opportunities to help generate stable returns.”

While private credit is gaining ground with investors, it remains a relatively new investment strategy and can often be misunderstood.

At the core, private credit is about providing capital solutions for transactions that show strong underlying value yet may not check all the boxes to qualify for traditional capital providers or which require more speed and certainty of execution than traditional sources can provide.

Broadly speaking, private credit investments can take on many forms. They can include direct corporate or consumer lending, venture debt, leveraged loans, infrastructure investments, etc. They can also include various types of real estate-based credit strategies.

Since 2008, Wilshire Finance Partners has invested in real estate based, fixed income private credit investments through short-term bridge loans, primarily in seniors housing, healthcare, multifamily, and commercial properties.

“The key difference between all private credit strategies and a real estate based private credit strategy is that the loan is backed by a hard asset—real estate,” Pelgrim explains. “However, it is not like direct real estate ownership. In our flagship WFP Income Fund, loans are made at lower loan-to-values (LTVs)—typically around 65%—meaning that the equity of the borrower and any subordinated financing on the property becomes a cushion or a buffer against potential loss for the Fund.”

“For example, if property values decline 15% in an economic downturn, there is an equity cushion to help safeguard the principal investments in the fund because the value of the collateral securing the loan exceeds the value of the loan,” Pelgrim adds.

With a background in real estate law and banking, CEO and Fund Manager Don Pelgrim looks for deals that typically fall just outside the parameters of a traditional lender or which have some level of complexity.

For example, it could be lending to an experienced operator with turnaround experience looking to purchase an underperforming or mismanaged assisted living facility.

“Because of the prior performance of the property, many traditional lenders may not consider or be prohibited against on the transaction. However, in private lending, understanding the value and potential of the underlying collateral and being able to conservatively underwrite some degree of risk takes a certain level of specialization,” Pelgrim says. “For example, an experienced operator with in-market turnaround experience and a successful history of transforming seniors housing facilities for the better sees an opportunity to acquire a facility at a very attractive cost basis. That operator is contributing his own cash to the equation and is also looking for a creative capital partner to provide the balance of capital needed.”   

In this situation, Wilshire would be open to providing a short-term bridge loan on the property because of the background, experience and track record of the borrower and the potential of the opportunity.

Private credit has filled a gap in the real estate market by providing short-term bridge loans with greater speed, flexibility, and efficiency.

“It’s really a win for all involved. We generate stable returns with downside protection for our investors by lending on a strategic acquisition and filling a capital need in the market. The new property owner increases the value of the property, and the residents benefit from a nicer, well-run facility.”

While some private credit strategies involve pursuing the highest yield, Wilshire’s approach is more balanced. A conservative investment approach and risk-mitigation strategies are the cornerstone to investor appeal.

In a well-diversified portfolio, a private credit strategy like Wilshire’s would fit in the middle of the investment risk pyramid, positioned as an alternative to other short term fixed income investments like corporate bonds.

Because the WFP Income Fund is not correlated to the stock and bond markets and has little to no sensitivity to interest rates, a lower-risk strategy that helps balance and diversify investment portfolios.

Private credit strategies are making their way into the mainstream as investors seek refuge from equity markets, and private lenders like Wilshire are stepping up to the plate to meet demand.

However, all private credit strategies and investment structures are not the same.  Facing market headwinds in 2023 and beyond requires a modern approach to portfolio allocation which, for many, includes alternative investments like real-estate based private credit.