Private Debt Investing

Private debt is an alternative means for investors to make fixed income returns. Traditionally, banks were the primary sources of credit for businesses, real estate investors, and the everyday individual. To fill in lending gaps and provide wider options for borrowers, private lenders offer loans in exchange for interest payments.

The potential for higher returns through private debt is one reason investors look to private debt as an alternative investment option. However, having access to better yields is not the only benefit investors are drawn to when investing through private debt. Portfolio diversification and risk management are also great advantages of private debt for retail and institutional investors.

Types of private debt

Venture debt

Private lenders invest in start-up companies by providing cash flow for business growth, innovation, and operations. Companies with a preference to retain equity structure opt for venture capital.

Infrastructure debt

Capital-intensive infrastructure projects usually require diverse sources of funding. A considerable cash inflow for infrastructure is syndicated private debt from investors looking to earn higher yields. Private debt funds projects in the energy, utilities, and transportation industries.

Real estate debt

Generally, real estate developments and acquisitions are capital intensive. Funding from banks may not be easily accessible. Even when banks provide financing, the options available may not be adequate or suitable for specific projects. For these reasons, the real estate industry also depends on cash flow from private lenders.

Private debt Funds

Most private lending opportunities are structured as funds. Investors can pool money together to fund large-scale projects and business needs.

Private Debt Funds- Mortgage Focus

Private debt funds are prevalent in the real estate industry. An example is mortgage funds set up to invest primarily in residential and commercial real estate. Investors’ funds provide private debt for individuals, developers, and builders to buy and build real estate properties.

Private mortgage funds in Canada are typically set up as mortgage investment entities such as a mortgage investment corporation (MIC). MICs have existed as far back as 1973, and they are governed by the Income Tax Act. MICs are a combination of residential and commercial mortgages.

The private residential mortgage debt investment market is a growing one. In 2022, MICs held about $13 billion to $14 billion of total residential mortgage debt in Canada. Overall, mortgage investment entities accounted for 8% of newly originated mortgages by lender type in 2020 and 2% of the entire residential mortgage market.

Mortgage investment entities are predominantly located in Ontario and British Columbia, followed by Alberta and Quebec.

Through private mortgage debt, investors can access yields in the range of 6- 11%. The potential for higher investment returns and the demand for private debt create an avenue for growth for mortgage investment funds and entities.

Mortgage investment companies are usually flow-through entities, transferring all income earned to investors as dividends. This type of private debt is an alternative fixed-income source, providing investors with periodic cash flow.

Pros of Private Debt for Investors

Why do investors consider private debt? Amongst many benefits of investing through private debt, the primary reasons investors provide funds for private lending include:

  • To diversify their investment assets
  • To earn risk-adjusted returns
  • To create an inflation hedge in an environment of rising prices
  • To add investments with a low correlation to conventional investments in
  • their portfolios
  • To earn fixed income cashflow
  • To manage portfolio volatility and market fluctuations

Investors and borrowers benefit from private debt. For borrowers, they have access to funding for consumer needs and business expenditures. Private lenders provide customized and accessible lending options, and this continues to drive the need for private debt.

Cons of Private Debt For Investors

Like other investments, private debt investing is not risk-free. The primary disadvantage to this investment is that it is illiquid; meaning investors will not be able to access their capital for 2-3 years. However, compared to other investments like private equity, private debt typically has lower risks due to a higher priority ranking in the case of company liquidation.

Realt® Investments is a commercial real estate mortgage fund specific to new home developments. It provides private mortgage-debt fund opportunities for investors. Through a rigorous mortgage approval process, called underwriting, the team provides funding for land, land development and new housing developments in return for interest rates that are paid back to investors.